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The Basel Controversy!
Guilty or Not Guilty?
Prepared and Presented by: Mohammad I. Fheili
Organizational Planning & devel...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Mohammad Fheili
“Over 30 years of Experience in Banki...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Who is to Blame?
 Lenders: for their predatory lendi...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Ongoing Effects:
 Sub-Prime mortgage industry collap...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Measures Taken By . . .
United States:
$700BN BAIL O...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Lessons in the process being learnt
 Development of ...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
The Swiss-
Cheese Model
The Steel
Model
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Justifying Government Intervention
Sudden changes in ...
If you were to Summarize Risk Management
in Three Words, what would they be?
Identify
Assess
Mitigate
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
1
3
You were asked
by a Zoo Keeper
to pick One
animal...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
It’s About Making Risk Choices
Identification Assessm...
Is Risk Management A
Destination?
Is Risk Management a
Destination?
 If your approach to risk
management is that it is a
destination by itself, . . .
 . ....
Bank’s Objective Function
 MAXIMIZE PROFIT subject to:
RISK Constraints
RISK . . .
 Default
 Liquidity
 Maturity
 Oth...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Nature of Risk Has Changed . . . !
Return
Risk
Return...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Increasing Understanding of Outcomes
IncreasingEviden...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Collect
them
all!
Data
Data
Data
Data
Data
Data
Data
...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
This is NOT Data Warehousing
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
How Do You Approach Data Collection? Look At
A Typica...
How do you Identify, Measure, and Manage Risk in
a Typical Banking Transaction?
e.g., Banking Transaction: Credit
Facility...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Dissect the Process, and Collect Data at Every
Step. ...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Credit Committees. . . Decision-Making Process !
Cred...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
• INADEQUATE Risk Management
• Inadequate Supervision...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Why not Blame Banking Innovations: Have Taken Place A...
History Testifies Against Basel . . .
. . . But, equally Important, it does not
free Bankers from potential guilt. . .
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Pre-
Basel
Credit Risk Credit + Market Risks Credit +...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Pre-
Basel
Credit Risk Credit + Market Risks Credit +...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Pre-
Basel
Credit Risk Credit + Market Risks Credit +...
Pre-
Basel
Credit Risk Credit + Market Risks Credit + Market +
Operational Risks
(Pillars 1, 2, and 3)
Present
and
Beyond
...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
MAXIMIZE PROFIT subject to:
RISK, REGULATORY, Complia...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
 By the late 1990s, the
Accord had come to be
seen a...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
 The Revised Framework
begins with a core
concept: A...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
e.g., The Credit Risk Function
Quantitative
Evaluatio...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Process of Internal Ratings
1
2
3
4
5
6
7
8
9
10
1
2
...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Pre-
Basel
Credit Risk Credit + Market Risks Credit +...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Basel II: Born with Serious Defects
Pillar I: Minimum...
The Revised Framework: Basel II . . . Geared
toward strict compliance
 The bulk of the revised framework is devoted to de...
Risk Weights
Credit Risk Under Standardized Approach
Regulatory
Capital =
Risk
Exposure
Risk
Weights
8%X X
0% 20% 50% 100%...
Risk Weights
PD
LGD
EAD
Correlations
Standardized
Approach
IRB Foundation
Approach
IRB Advanced
Approach
Credit Risk
Model...
Risk Weights . . .
Direct Claims on-balance
sheet
 All Approaches to defining
risk-weights generate wide
variation in wei...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Risk Weights . . .
Off-balance sheet Items
 Basel II...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
ORM Under Pillar I
Basic Approaches
Advanced Approach...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Capital Charge for Operational Risk
 Gross Income is...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Standardised Approach
Corporate Finance
Trading & Sal...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
ORM Advanced Measurement Approach - AMA
Operational R...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Total capital
Credit risk + MARKET RISK + Operational...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Market Risk
 Interest Rate Risk
(Trading)
 Equity P...
The Role Played By Basel II In The Financial
Crisis
 The average level of capital required by the new
discipline is inade...
The Role Played By Basel II In The Financial
Crisis
 The key assumption that bank’s internal models for
measuring risk ex...
The Revised Framework: As It Should Have
Been, But . . .
Capital Requirements
for Credit Risk
 Standardized Approach
 Fo...
Pillar I: Supervisory Review of
Capital Adequacy
Pillar I is based on four Key Principles:
 Bank’s own assessment of capi...
ICAAP: Internal capital Adequacy
Process
 Risks Analyzed: An identification of the major risks faced
in each of the follo...
ICAAP Total Variations in a
single Process
Un-Anticipated
Variations
Anticipated
Variations
(Provisions, Transfer, Etc)
Pr...
1) Regulatory Arbitrage
2) Insensitivity to Portfolio Diversification
3) A Substitute for Management Judgment
4) Procyclic...
Regulatory Arbitrage Drives capital
Out of the System
 Large variations in risk
weights (and CCFs)
encourage regulatory
a...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Regulatory Arbitrage Drives capital
Out of the System...
Insensitivity to Portfolio Diversification Encourages
Excessive Exposure to Favored Asset Classes.
 The capital
required ...
The Rules of Basel II Provide a Government Stamp of
Approval and Can Substitute for Management Judgment
 Pillar 2 accords...
The Revised Framework is pro-cyclical and
can Exaggerate Booms and Busts
Rising profits in the upswing usually generate in...
Capital Requirements for Banking Subsidiaries
May not be Adequate at Group Level
 Basel II is to be applied on a consolid...
Subjective Inputs
 Risk inputs are subjective.
 Some prices are of the over-the-counter variety and are not
observable, ...
Unclear and Inconsistent Definitions of
Capital
 Regulatory adjustments for goodwill are not mandated to
apply to common ...
Supervisors Have Not Been Known To Be
Forward Looking.
 Building capital buffers under Pillar 2 (Stress Testing, . . . )
...
Markets Just Aren’t Efficient
 Pillar 3 relies on disclosure and market discipline that will
punish banks with poor risk ...
Strengthen the Global Financial System by:
1) Raising capital Requirements,
2) Increasing Capital Levels,
3) Improving Ris...
Improving the Quality of Capital
 Equity is the best form of capital, as it can be used to write off losses.
 Goodwill. ...
The Proposed New Basel III
Framework
 Minimum Common Equity: The highest form of loss-
absorbing capital, this threshold ...
The Proposed New Basel III
Framework
 A Counter-Cyclical Buffer (0% to 2.5%) also could be imposed by
countries in order ...
Basel III Minimum Capital Requirements
0
1
2
3
4
5
6
7
8
9
10
11
2
0
1
0
2
0
1
1
2
0
1
2
2
0
1
3
2
0
1
4
2
0
1
5
2
0
1
6
2...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Equity Instruments that no-longer qualify as Tier 1 o...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Leverage and Liquidity Ratios
2
0
1
0
2
0
1
1
2
0
1
2...
The Proposed New Basel III
Framework
 A non-risk-based leverage ratio will also be introduced in
2018. It is currently pr...
Existed Way Before Basel Ever Did . . .
Bank Capital
Back to the ABC of Bank Capital: The Good Old Days!
It’s a
Wonderful
Life!
What is Bank Capital?
 Is bank’s net worth, which equals the difference between
total assets and liabilities.
 Is a cush...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Internal . . .
Internal
 The level of capital which ...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
External . . .
External
 The level of capital which ...
Why is Bank Capital Important?
 The amount of capital affects return on investment for the equity
holders (owners) of the...
How Do Banks Raise Capital?
Banks can raise capital by:
 issuing new equity (common stock),
 Issuing bonds that can be c...
Role of Bank Capital Requirements in the
Recent CRISIS and How Higher Reserves Could
Have Averted Bank Failures
 Higher b...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
The Basics: Types of Capital
DEBT CAPITAL
 What will...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
Basel II Capital Structure, Ratios and Deductions
CAP...
Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
 ( - ) Goodwill: Tier 1 capital of the new
bank (acq...
Components of Capital
Components Minimum Requirements
Core Capital (Tier 1)
Common stockholders’ equity
Qualifying, nonc...
New Basel Capital Requirements
Old Standards New Standards
Amount 
Includable in 
Total Capital
Elements of Capital
No Lim...
The Million
Dollar
Question
Can Bank Capital
Regulation
Prevent Future
Financial Crises?
Bank Regulation: Proposed Changes to
Corporate Governance
Introduction: Why Change Corporate
Governance?
 Proposed changes to the internal structure of
corporations can be divided...
The Corporate Structure of a Bank
 The corporate structure of banks is divided into three
branches: Shareholders, Directo...
The Corporate Structure of a Bank: Board of
Directors
 Board of Directors: besides making employment decisions and
monito...
The Corporate Structure of a Bank: Managers,
(Focus on CEO)
 The CEO is responsible for running the bank on a daily
basis...
Managers & Compensation
 Managers are paid a contracted salary, and frequently a
performance measured bonus; compensation...
Failure within Corporate Governance
• The lingering financial problems with the 2007-08
crisis stem from shaken investor c...
Failure within Corporate Governance
 Personal response: the failure of corporate
governance comes primarily from two sour...
Corporate and Financial Institution Compensation
Fairness Reform
 Finally, the Bill directs federal regulators to craft
r...
The Pros and Cons of Corporate Governance
Reform
 Pros:
 Moral hazard incentive problems
 Despite decreases in market c...
Credit Rating Agencies
Background
 3 Biggies – Fitch, S&P and Moody’s
 Others in US
 Basel’s list of internationals
 History
 Generally good...
What They Do
 Issue Rating
 Once upon a time paid for by investors, now paid for by
issuers of the securities
 Used as ...
What They Do . . .
 Uses of Credit Ratings
 Most issues of bonds need at least one rating in
order to increase their mar...
What They Do . . .
 Advisory Services
 Advise issuers on how to structure
instruments in order to obtain the maximum
yie...
What They Do . . .
 Advisory Services create lowest possible quality at
each rating level (regulatory arbitrage-type patt...
Regulatory Reliance . . .
 Basel II – recognized ratings from External Credit
Assessment Institutions (ECAI’s)
 Allows r...
Regulatory Structure
General Increase in Government
Intervention
• Safety Nets
• Bail outs
• Deposit insurance
• Discount windows
Decrease
indu...
General Increase in Government
Intervention
• Regulations
• Heightened
Supervisory
Power
• Requires market
discipline
• Im...
General Increase in Government
Intervention
• Increase market discipline
• Increase cost efficiency
• Increase profit effi...
General Increase in Government
Intervention
 Increased Regulation requires increased information
disclosures
 Informatio...
Thinking Beyond Basel III
Preparing For The Next Crisis
Basel III designed in Swiss style.
*A committee has been set up to
discuss the benefits of using a Mark
to “how you feel t...
The Rear View Mirror
 • The past 3 years have been unprecedented:
 Failure of numerous large institutions across the glo...
Learning from the past – ‘Rogue Trading’
 During 2008, Societe Generale reported a
loss of €4.9bn due to a number of unau...
Expecting the unexpected
The last few years have seen the demise of significant local,
national and global financial servi...
Complexity of business failures
 Often, there will be numerous factors that lead to the
collapse of an organization e.g.
...
Key Challenges for the Future of the Financial
Service Industry
 • Continued economic uncertainty
 Impact of unraveling ...
 • Regulatory supervision
 Intensive / intrusive supervision of larger firms
 Greater focus on individual responsibilit...
What Does this Mean for Risk Managers?
 Risk managers will need to adopt the CRO perspective
 Appreciation / awareness o...
 Greater scrutiny of risk functions and risk managers
 Demonstrating success
 Increasing demand for skilled individuals...
Who Is The Supervisor?
Who Is The Banker?
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My 2010 basel accord controversy

It is more of a brainstorming presentation of the Basel Accord Controversy. Although it dates back to 2000, most of it still holds to date.

  • Seja o primeiro a comentar

My 2010 basel accord controversy

  1. 1. The Basel Controversy! Guilty or Not Guilty? Prepared and Presented by: Mohammad I. Fheili Organizational Planning & development Specialist M I Fheili & Associates mifheili@terra.net.lb & mifheili@gmail.com Mobile: +961 3 337175 & +961 71585660
  2. 2. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Mohammad Fheili “Over 30 years of Experience in Banking. mifheili@gmail.com (961) 3 337175  Risk & Capacity Building Specialist.  Trainer in Risk, Compliance, and Capacity Building.  University Lecturer: Economics, Risk, and Banking Operations  Currently serves in the capacity of an Executive (AGM) at JTB Bank in Lebanon.  Served as: • Senior Manager & Chief Risk Officer at Group Fransabank • Senior Manager at BankMed • Talent Development Advisor at ABL • Economist at the Association of Banks in Lebanon [ABL]  Mohammad received his college education (undergraduate & graduate) at Louisiana State University (LSU), and has been teaching Economics and Finance for over 25 continuous years at reputable universities in the USA (LSU) and Lebanon (LAU).  Finally, Mohammad published over 25 articles, of those many are in refereed Journals (e.g., Journal of Money Laundering & Control; Journal of Operational Risk; Journal of Law & Economics; etc.) and Bulletins.”
  3. 3. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
  4. 4. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Who is to Blame?  Lenders: for their predatory lending practices focused on sub- Prime mortgage candidates  Rating Agencies: Overrate the MBS and other derivatives with underlying securities of little value with full knowledge.  Mortgage brokers: for steering borrowers to unaffordable loans  Appraisers: for inflating housing values  Wall Street investors: for backing sub-Prime mortgage loans without first verifying the security of the portfolio  Borrowers: for overstating income levels on loan applications and entering into loan agreements they could not afford  Government: for lack of oversight
  5. 5. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Ongoing Effects:  Sub-Prime mortgage industry collapses, thousands of jobs are lost  Surge of foreclosure activity  Housing prices and sales are both down  Interest rates rise across the board as the effects of the collapse of the sub-Prime mortgage industry seep into the near-prime and prime mortgage markets  Investors lost billions of dollars in securities tied to the sub- Prime mortgage industry, resulting in upheavals throughout the global financial market
  6. 6. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Measures Taken By . . . United States: $700BN BAIL OUT PLAN; Fed cut key interest rate to 1% United Kingdom: Govt injected cash of £37bn into 3 major banks Bank of England cuts interest rate to 4.5% Germany: €500bn financial rescue Japan: Bank of Japan cuts interest rate to 0.3% 1.8trillion yen stimulus plan Brazil: Abandons its tax on foreign investment. Plans to sell $50bn in dollar swap futures contracts to defend currency. Russia: 950bn Rouble long term funding to Banks 1.3trillion Rouble to State-run Vnesheconombank to service Russian Banks’ foreign loans China Abandons its tax on foreign investment Plans to sell $50bn in dollar swap futures contracts to defend currency
  7. 7. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Lessons in the process being learnt  Development of speculative real estate markets and lax standards of credit appraisal are the surest routes to economic disaster  Rating instrumentality is no substitute to independent due diligence  Higher capital allocation with or without Basel II or prospective Basel III is no insurance for bank failures triggered by systemic, people and process failures  Sophisticated mathematical models, notwithstanding back testing, stress testing and the like hardly forebode collapses.  GAAP is not enough  Macro prudential analysis (MPA) requires revisit  High degree of flexibility is required in the choice of benchmarks  Appetite for mergers and acquisitions move in a new direction  Injecting liquidity through equity is a better route than a bail-out package  Regulators to keep watch on leverage ratios more than the capital.
  8. 8. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > The Swiss- Cheese Model The Steel Model
  9. 9. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Justifying Government Intervention Sudden changes in asset quality and value can quickly wipe out bank capital. Where short-term wholesale liabilities fund longer-ion and investment term assets, failure to roll over short-term financial paper, or ‘run’ on deposits, can force de-leveraging and asset sales. Banking crisis associated with such changes are often systemic in nature, arising from the interconnectedness of financial arrangements: banks between themselves, with derivative counterparties and with direct links to consumption and investment decisions.  It is for this reason that policy makers regulate the amount of capital that banks are required to hold, and require high standards of corporate governance, including liquidity management, accounting, audit and lending practices.
  10. 10. If you were to Summarize Risk Management in Three Words, what would they be? Identify Assess Mitigate
  11. 11. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > 1 3 You were asked by a Zoo Keeper to pick One animal to take care of, for a day, inside a 25m2 room; and alone? Feel free:  To ask any question. I’m the Animal Keeper!  To do what you deem necessary to succeed. 2 4
  12. 12. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > It’s About Making Risk Choices Identification Assessment Mitigation Key Risks Identified Risks Non- Identified Risks ? ? Acceptable Risks Un- Acceptable Risks ? Control Transfer Avoid! Finance RiskTakersinlinewithexistingpolicies
  13. 13. Is Risk Management A Destination?
  14. 14. Is Risk Management a Destination?  If your approach to risk management is that it is a destination by itself, . . .  . . . Then “Compliance” is your “cup of tea”, and you have effectively transferred the burden of decision-making to the hands of the supervisors  If your approach to risk management is that it is a process leading to . . . An End  Then, you have taken matters into your own hands!
  15. 15. Bank’s Objective Function  MAXIMIZE PROFIT subject to: RISK Constraints RISK . . .  Default  Liquidity  Maturity  OtherTypes of Risks Uses of Funds Sources of Funds  Reserves  Loans  Securities  Other Investments  Fixed Assets  . . .  AllTypes of Deposits  Borrowings  Other Sources  Equity Capital  . . . . . . and Off-Balance Sheet . . .
  16. 16. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Nature of Risk Has Changed . . . ! Return Risk Return Risk Speculative Risk Managing Revenue Hazard + Others Managing Costs CreditRisk MarketRisk Reputation& OtherRisks Operational Risk Best Practices in Risk Management: Risk = Speculative + Hazards Risk is Here to Stay . . .
  17. 17. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >
  18. 18. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Increasing Understanding of Outcomes IncreasingEvidenceonProbability Risk Uncertainty Ambiguity Ignorance Consequences are increasingly uncertain LikelihoodisIncreasinglyUncertain But Managing RISK is not a guessing game, it is a DATA-RICH Process
  19. 19. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Collect them all! Data Data Data Data Data Data Data Data Data Collect All The Data . . . To Improve Upon Your Ability To Make Good Decisions
  20. 20. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > This is NOT Data Warehousing
  21. 21. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > How Do You Approach Data Collection? Look At A Typical Banking Organization LOGISTICS  Information Technology  Human Resources  Administration  Others RISK & CONTROL  Risk Management  Internal Audit  Internal Controls  Inspections  Others BANKING  Retail Banking  Corporate Banking  Treasury  Private Banking  Others Support Functions (Cost Centers) Business Generators (Speculative Behavior) Board of Directors With well defined sets of duties & responsibilities With well defined sets of duties & responsibilities Typical Transaction: Start . . . . (goes through the entire banking organization) . . . End Before . . . During . . . After . . .
  22. 22. How do you Identify, Measure, and Manage Risk in a Typical Banking Transaction? e.g., Banking Transaction: Credit Facility Approval Process
  23. 23. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Dissect the Process, and Collect Data at Every Step. E.g., Credit Approval Process Acquisition/ Credit Specific Customer Service Collect And Review Data Credit Review Assess Collateral And Risk Document Approval Sales: Bank-Client Interface Risk Analysis: Pricing the Facility Processing Establishing Contact Evaluate first customer info Customer Meetings Debriefing Request documents Obtain data & information Completeness / plausibility review Follow up Review document Follow up with Loan Officer / Account Manager Standardized Credit Rating Document on other credit related factors Inspect Object Determine Loan-to- value Evaluate Exposure Data is Sufficient Complete Loan Application Prepare Credit rate Handover Credit File Follow Up Data is Complete Approval by Decision Makers Check Compliance with Authority Structure Prepare Contracts Get Signatures Provide Security Disbursement Review Disbursement Plan Monitor & Report Resolution Correlations & Loan Portfolio Considerations Loan/Asset Life Cycle Credit Approval Process Implement On the Credit Decision
  24. 24. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Credit Committees. . . Decision-Making Process ! Credit Authority by Total Exposure Small Exposure Medium Exposure Large Exposure Very Large Exposure Investment Exposure Sales Risk Analysis Corporate Board Sales Locations Sales Manager Risk Analysis Head of Risk Analysis Executives Supervisory Board Credit Committee - Account Manager - Group Leader - Risk Analyst - Group Leader + + + + + + + First Vote Assessment Assessment Assessment Assessment Opinion Opinion First Vote First Vote Second Vote Second Vote Analysis Analysis Analysis Analysis Second Vote Opinion Opinion First Vote Second Vote First Vote Second Vote - - - - - - - - - - - - - - - - - - - - Second Vote
  25. 25. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > • INADEQUATE Risk Management • Inadequate Supervision • LAX Governance • ABSENCE of Required Competencies • Inadequate Enforcement of Internal Policies and Procedures • LACK of Transparency • Inadequate Disclosure Why Banks Fail? Banking weaknesses in most failures were unrecognized in due time because they were CAMOUFLAGED with the hope that none shall ever be discovered! By the time “BANK FAILURES” were discovered, it was impossible to do away with drastic measures to resolve them! If Bankers Have Been Doing Their Jobs Right, Bank Failures would Not Reach A Catastrophic Proportions. . .
  26. 26. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Why not Blame Banking Innovations: Have Taken Place At A Rate Faster than Employees Have Been Able to Digest . . . Risky Business  New products  Product sophistications  New distribution channels  New markets  New technology  Complexity (IT- Interdependencies, data structures)  E-commerce  Processing speed  Business volume  Globalization  Shareholder and other stakeholder pressure  Mergers & Acquisitions  Re-Organizations  Staff turnover  Cultural diversity of staff and clients  Faster ageing of know-how  Rating Agencies  Insurance Companies  Capital Markets  Others . . . . Trust between the Financial Supervisory Authorities and Banks/Bankers have come under serious questions . . . !
  27. 27. History Testifies Against Basel . . . . . . But, equally Important, it does not free Bankers from potential guilt. . .
  28. 28. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Pre- Basel Credit Risk Credit + Market Risks Credit + Market + Operational Risks (Pillars 1, 2, and 3) Present and Beyond 1 9 8 8 1 9 9 6 1 9 9 8 2 0 0 1 2 0 0 4 2 0 0 8 2 0 0 9 2 0 1 3 Market Risk Basel II Consultation Starts Finalization of Revised Framework Basel III Proposals Basel I Basel II Basel III ? Jul. Jan. Jan.Dec. __The Basel Committee of Banking Supervision was established in 1974 at the Bank for International Settlements (BIS) > > > each member is represented by its Central Bank and the authority responsible for domestic banking supervision. The Original Mandate was to deal with the regulatory challenge posed by the increasing internationalization of banking in the 1970s. __The collapse of the German Herstatt Bank and the New York-based Franklin National Bank in 1974 showed that financial crises were no longer confined to one country, and that coordinated international action was needed to prevent future crises from spilling over borders. __The Committee’s first proposal, the 1975 Basel Concordat, established rules determining the responsibilities of home and host country regulators vis-à-vis cross-border banks.
  29. 29. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Pre- Basel Credit Risk Credit + Market Risks Credit + Market + Operational Risks (Pillars 1, 2, and 3) Present and Beyond 1 9 8 8 1 9 9 6 1 9 9 8 2 0 0 1 2 0 0 4 2 0 0 8 2 0 0 9 2 0 1 3 Market Risk Basel II Consultation Starts Finalization of Revised Framework Basel III Proposals Basel I Basel II Basel III ? Jul. Jan. Jan.Dec. __The Committee’s focus expanded in 1980s as American regulators looked for a way to share the regulatory burden imposed on its banks after the Latin American Debt Crisis of 1982. In response, American regulators seized on the Basel Committee to establish a common framework for the capital regulation of internationally active banks, the 1988 Accord on Capital Adequacy (Basel I). __The 1988 Accord set minimum capital requirements based on a ratio of capital to risk-weighted assets of 8%. Assets were risk-weighted according to the identity of the borrower. __Whose job was to secure compliance with Basel I? The Financial Control Division of the banking organization (Not Risk Management; most likely because risk management did not exist in the org structure of the bank then.
  30. 30. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Pre- Basel Credit Risk Credit + Market Risks Credit + Market + Operational Risks (Pillars 1, 2, and 3) Present and Beyond 1 9 8 8 1 9 9 6 1 9 9 8 2 0 0 1 2 0 0 4 2 0 0 8 2 0 0 9 2 0 1 3 Market Risk Basel II Consultation Starts Finalization of Revised Framework Basel III Proposals Basel I Basel II Basel III ? Jul. Jan. Jan.Dec. Basel I: Minimum Capital, Basic Risk Weighting Basel II: Changes to Risk Weights, Second and Third Pillars not implemented in full (Practically) Basel III: Changes to Risk Weights, Changes to definition of Capital, New (experimental) measures, Accounting Complications
  31. 31. Pre- Basel Credit Risk Credit + Market Risks Credit + Market + Operational Risks (Pillars 1, 2, and 3) Present and Beyond According to the Basel Committee, the Accord have the following objectives:  To promote safety and soundness in the financial system  To enhance competitive equality  To constitute a more comprehensive approach to addressing risk. Basel I Basel II Basel III
  32. 32. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > MAXIMIZE PROFIT subject to: RISK, REGULATORY, Compliance, Reporting, Etc. Constraints RISK . . .  Default  Liquidity  Maturity  Others ... REGULATORY . . .  Basel I  Basel II  Basel III  Basel IV (In the making)  TLAC Requirements  Sanctions Rules  USA_FATCA Requirements  OECD_CRS (1st Reporting 2017)  IFRS9  AML, Etc. . . . Uses of Funds Sources of Funds  Reserves  Loans  Securities  Other Investments  Fixed Assets  . . .  AllTypes of Deposits  Borrowings  Other Sources  Capital  . . . Off-Balance Sheet Legal Issues . . . From Originate- To-hold To Originate-To- Distribute (Decompose & Redistribute) CRS: Common Reporting Standards, essentially inspired by FATCA, is a framework between governments to exchange information obtained from local financial institutions to combat tax evasions. TLAC: The Proposed Minimum Total Loss Absorbing capacity requirements for Globally Systemically Important Banks (G-Sibs). It aims to boost G-Sibs’ capital and leverage ratios, ensuring these banks are equipped to continue critical functions without threatening financial market stability or requiring taxpayer support. Instead of to Off- Balance Sheet; now to Unregulated Shadow Banking with less concerns over loan monitoring & Follow up. Used as a Cushion with loss- absorbing capacity or as a Source of Funding! The Banking Model… Complex
  33. 33. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >  By the late 1990s, the Accord had come to be seen as a blunt instrument that was “Useless for Regulators and Costly for Banks”.  . . . Banks succeeded in exploiting the difference between economic risk and regulatory risk to reduce capital levels without reducing exposure to risk. Banks arbitraged Basel I’s Capital requirements in two ways:  They moved toward the riskier assets within a given risk weight category, which have a higher yield.  They shifted assets off the balance sheet, typically securitizing them. These assets were treated as true sales for regulatory purposes, even though the bank often retained much of the underlying risk through credit enhancements. Pre- Basel Credit Risk Credit + Market Risks Credit + Market + Operational Risks (Pillars 1, 2, and 3) Present and Beyond Basel I Basel II Basel III
  34. 34. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >  The Revised Framework begins with a core concept: A Distinction between “Expected” and “Unexpected” losses.  Expected losses in any given year can and should be managed by “Pricing” or through “provisioning”.  But Supervisors want a buffer in the form of Capital to be held for Unexpected, or occasional peak, losses. This Capital Buffer will serve to:  Limit Insolvencies  Absorb losses that could activate explicit or implicit government guarantees.  Ensure confidence in the financial system.  . . . Need to establish balance between the costs and benefits of holding capital. Pre- Basel Credit Risk Credit + Market Risks Credit + Market + Operational Risks (Pillars 1, 2, and 3) Present and Beyond Basel I Basel II Basel III
  35. 35. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > e.g., The Credit Risk Function Quantitative Evaluation Qualitative Evaluation Internal Rating Financial Data Mitigation Matrix Probability of Default - PD Loss Given Default - LGD Exposure At Default - EAD Correlation Risk Components Calculation Of Credit Risk Amount (Measurement Model of Credit Risk) Stress Testing Expected Loss (EL) Unexpected Loss (UL) (Single Asset And Portfolio) < Internal Rating Systems > < Quantification of Credit Risk > Reporting to The Board Portfolio Monitoring Provisioning Pricing Profit Management Capital Allocation < Internal Use >
  36. 36. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Process of Internal Ratings 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Borrower’s Financial Data Quantitative Rating Model Borrower’s Qualitative Information Default ProbabilityofDefaultPer RatingGrade Assessing Ratings Estimation of PD Quantitative Evaluation Qualitative Evaluation Initial Evaluation (tentative) Final Rating Rating Mitigation (Later) ------- Normal Bankrupt Needs attention How to set the time horizon of assessing the creditworthiness of borrowers in assigning ratings: Point-In-Time (PIT) and Through-The-Cycle (TTC) Two-Tier Rating System: Obligor and Facility Ratings
  37. 37. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Pre- Basel Credit Risk Credit + Market Risks Credit + Market + Operational Risks (Pillars 1, 2, and 3) Present and Beyond 1 9 8 8 1 9 9 6 1 9 9 8 2 0 0 1 2 0 0 4 2 0 0 8 2 0 0 9 2 0 1 3 Market Risk Basel II Consultation Starts Finalization of Revised Framework Basel III Proposals Basel I Basel II Basel III ? Jul. Jan. Jan.Dec. Basel II is no longer in the embryonic tube
  38. 38. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Basel II: Born with Serious Defects Pillar I: Minimum Capital Adequacy Ratios Calculation Of Exposure Calculation of PD/LGD Calculation of RWA Adjustments for Collateral Valuation Adjustments for Credit Mitigants Netting Balance Sheet Items Calculations Of Risk Weights Based on PD/LGD Supervisory Risk Weights and LGD Standardized Approach IRB (Foundation) IRB (Advance) Value at Risk Standardized Measurement Methods Interest Rate Risk Equity Position Risk Forex Risk Commodities Risk Treatment of Options Support for all Three Approaches Basic Indicator Approach: Capital is calculated as a percentage of Gross Income Standardized Approach: line of Business Based Exposure Indicators Advanced Measurement Approach: Capital Computations as per LDA Credit Risk Traded Market Risk Operational Risk External/Internal Rating Systems Pillar II: Supervisory Oversight Pillar III: Market Discipline Usage of Metadata which Enables transparency Capital for other Risks Rules-Based Engines Risk Assessment Reports Capital Adequacy Reporting Flexible Reporting Quantitative Reporting-IFRS 7 Qualitative Reporting-IFRS 7
  39. 39. The Revised Framework: Basel II . . . Geared toward strict compliance  The bulk of the revised framework is devoted to deriving the various formulas and parameters needed to calculate minimum capital requirements under Pillar 1. It:  Defines “total risk-weighted assets” on the basis of a complex system of risk-weighting that applies to three types of risks: Credit, Market, and Operational.  Defines “regulatory capital”  Requires that the ratio of regulatory capital to risk- weighted assets be no lower than 8%.  . . . The risk-weights have been at the heart of the problem.
  40. 40. Risk Weights Credit Risk Under Standardized Approach Regulatory Capital = Risk Exposure Risk Weights 8%X X 0% 20% 50% 100% 150% Loans, Bonds, Etc. Regulatory Capital Off-Balance Sheet Items Liabilities Against Customers ASSETS LIABILITIES Credit Conversion Factors Type of ObligorGovernment within OECD Banks within OECD e.g., mortgages under certain conditions Corporates, Inc, Insurance Companies
  41. 41. Risk Weights PD LGD EAD Correlations Standardized Approach IRB Foundation Approach IRB Advanced Approach Credit Risk Models 6 Supervisor Supervisor Supervisor No More Bank Supervisor Supervisor No More Bank Bank Bank No More Bank Bank Bank No Self RegulationsStrict Compliance
  42. 42. Risk Weights . . . Direct Claims on-balance sheet  All Approaches to defining risk-weights generate wide variation in weights which depend on the classification of the credit. The large differences in these risk weights create strong opportunities for a form of regulatory arbitrage: Banks can “free up capital” by shifting portfolio exposure from high risk-weighted assets to lower risk-weighted assets.  The shift from Basel I to Basel II will “free up capital”, notably as regards residential mortgages and retail lending since the risk-weights mostly come down.  The IRB approach allows greater sensitivity to the probability of default (PD) for any given type of loan but it does not mitigate the wide differences in risk-weights across loan characteristics observed with Basel I and either version of the standardized approach. . . IRB provides great scope for using lower risk weights.
  43. 43. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Risk Weights . . . Off-balance sheet Items  Basel II aims to create more neutral incentives as regards off-balance sheet exposures, which are converted to balance sheet equivalents by “credit conversion factors (CCFs)”.  The CCFs are very varied, depending on the type of exposure, and create arbitrage opportunities. Structured Products Treatment depends on a number of parameters:  Where banks use IRB approach for the type of underlying exposures being securitized, risk weights depend on external ratings where these are available (7% - 100%)  Standardized approach, exposures B+ and below must be deducted totally from capital  Originating banks may exclude securitized exposures where the risk is fully transferred.  Exposures which are in effect off-balance sheet require a CCF . . .
  44. 44. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > ORM Under Pillar I Basic Approaches Advanced Approaches CRUDE generating high capital charge SOPHISTICATED generating low capital charge Standardised ApproachesPillar1-incentives Subject to qualitative entry criteria Pillar2-soundpractices Subject to qualitative entry criteria
  45. 45. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Capital Charge for Operational Risk  Gross Income is defined as the sum of net interest income and net non- interest income  BIA: When the gross income is negative in any of the three years it is excluded from the calculations  Income from loans and other interest bearing assets  Less: cost of deposits and other interest bearing liabilities  Plus: Fees & commissions  Plus: Net income from other trading activities Basic Indicator Approach The Entire Business Organization Financial Indicator is a Proxy for Operational Risk Scaling factor Total Capital Charge 3-year Avg. Gross income * 15% = * =
  46. 46. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Standardised Approach Corporate Finance Trading & Sales Retail Banking Commercial Banking Payment Settlements Asset Management Agency Services Retail Brokerage 1 2 3 4 5 6 7 8 BL1 Gross income BL2 Gross income BL3 Gross income BL4 Gross income BL5 Gross income BL6 Gross income BL7 Gross income BL8 Gross income * 18% = * 18% = * 12% = * 15% = * 18% = * 12% = * 15% = * 12% =  Financial Indicator is a Proxy for Operational Risk Scaling factor Total Capital Charge * = Capital Charge for Operational Risk Gross Income (same as in BIA) represents the income from “normal” banking activities & should not include:  Any provision  Any operating expenses  Profits/losses from the sale of securities in the banking book  Extraordinary or irregular items  SA: It is always a 3-year average gross income (negative values for aggregate Gross Income are replaced with zero)  SA and BIA assume that the level of operational risk a bank runs is directly proportional to the size of its gross income  The use of gross income as risk exposure indicator is far simple than the use of risk- weighted assets
  47. 47. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > ORM Advanced Measurement Approach - AMA Operational Risk [Reporting] is broken down into event types as they cut across business lines Internal fraud External fraud Employment Practices and Workplace Safety Clients, Products & Business Practices Damage to Physical Assets Business Disruption and systems failures Execution, Delivery & Process Management Corporate Finance Trading & Sales Retail Banking Commercial Banking Payment and Settlements Agency Services Asset Management Retail Brokerage loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data loss data QIS: Quantitative Impact Study
  48. 48. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Total capital Credit risk + MARKET RISK + Operational risk = CAR ≥ 8%  Market risk element of the denominator is the market risk requirement relating to Trading Book and Part of Banking Book.  Rules were introduced in the 1996 Market Risk amendment to Basel I and largely unchanged under Basel II Credit risk Market Risk Operational risk Minimum Capital Requirements for Market Risk
  49. 49. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Market Risk  Interest Rate Risk (Trading)  Equity Position Risk  FX Risk  Commodity Risk  Specific Risk  Interest Rate Risk (Banking)  Liquidity Risk Market Risk Traded Market Risk Treasury Risk On and Off-Balance Sheet positions arising from movement in market prices Loss of value of the investments (Continually buying and selling financial instruments) The business the bank conducts with its customers (Lending and Deposit Taking activities)
  50. 50. The Role Played By Basel II In The Financial Crisis  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.  The new Capital Accord, interacting with fair-value accounting, has caused remarkable losses in the portfolios of intermediaries.  Capital requirements based on the Basel II regulations are cyclical and therefore tend to reinforce business cycle fluctuations.  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.
  51. 51. The Role Played By Basel II In The Financial Crisis  The key assumption that bank’s internal models for measuring risk exposures are superior than any other has proved wrong.  The new framework provides incentives to intermediaries to deconsolidate from their balance sheets some very risky exposures  The interaction between minimum capital requirements, a supervisory review process and market discipline is the way to pursue the soundness of banks as well as the stability of the entire financial system. This interaction was lacking!
  52. 52. The Revised Framework: As It Should Have Been, But . . . Capital Requirements for Credit Risk  Standardized Approach  Foundation IRB Approach  Advanced IRB Approach Traded Market Risk  Standardized Approach  Internal VaR Models Operational Risk  Basic Indicator Approach  (Alternative) Standardized Approach  Advanced Measurement Approach Regulatory Framework for Banks  Internal Capital Adequacy Assessment Process (ICAAP)  Risk Management Supervisory Framework  Evaluation of Internal Systems of Banks  Assessment of Risk Profile  Review of Compliance with all Regulations  Supervisory Measures Disclosure Requirements of Banks  Transparency for market participants concerning the Bank’s Risk Position (Scope of Application, Risk Management, Detailed Information on own funds, etc.)  Enhanced Comparability of Banks Financial Stability Pillar II: Minimum Capital Requirements Pillar I: Supervisory Review Process Pillar III: Market Disclosure & Discipline
  53. 53. Pillar I: Supervisory Review of Capital Adequacy Pillar I is based on four Key Principles:  Bank’s own assessment of capital adequacy (i.e., the principle of Proportionality) irrespective of size and/or complexity.  Supervisory Review Process  Capital Above Regulatory Minima  Supervisory Intervention
  54. 54. ICAAP: Internal capital Adequacy Process  Risks Analyzed: An identification of the major risks faced in each of the following categories:  Credit Risk  Market Risk  Operational Risk  Liquidity Risk  Insurance Risk  Concentration Risk  Residual Risk  Securitization Risk  Business Risk  Interest Rate Risk  Pension Obligation Risk  Any other risks which have been identified
  55. 55. ICAAP Total Variations in a single Process Un-Anticipated Variations Anticipated Variations (Provisions, Transfer, Etc) Process Capability Study Discover And Eliminate Causes Of Un-Anticipated Variations Compute Central Tendency And Variability Natural Limits / Appetite for Risk/ Tolerance for Risk Risk Financing Catastrophic
  56. 56. 1) Regulatory Arbitrage 2) Insensitivity to Portfolio Diversification 3) A Substitute for Management Judgment 4) Procyclicality 5) Capital for Subsidiaries versus Group Level Key Features in Basel II To Be Reconsidered
  57. 57. Regulatory Arbitrage Drives capital Out of the System  Large variations in risk weights (and CCFs) encourage regulatory arbitrage which reduces capital requirements as portfolios are weighted toward favored asset classes.  As total risk-weighted assets decline as a share of actual total assets, the leverage that a given amount of capital can support under the regulations rises.  Lending without additional capital backing  Return capital to shareholders  The end result: very low levels of equity backing for the balance sheet.  Banks face very low risk- weights under Basel I so long as investment grade credit ratings (BBB- or above) are maintained; this continued under Basel II. Incentives to Increase Leverage
  58. 58. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Regulatory Arbitrage Drives capital Out of the System  Residential mortgages, which have constituted the underlying assets in many of the asset backed securities that have been at the root of the crisis, have been strongly privileged under all versions of the Basel framework.  Banks originating securitizations have great scope to reduce their risk-weighted exposures or to exclude them all together.  Under the IRB approach of Basel II senior trenches of securitized claims rated BBB+ or above carry low risk weights (7 to 35%)  This system clearly provides incentives and great scope for channeling credit to home mortgages, many of them funded in wholesale markets and eventually securitized, with very little equity capital backing.
  59. 59. Insensitivity to Portfolio Diversification Encourages Excessive Exposure to Favored Asset Classes.  The capital required as backing for any given loan should only depend on the risk of that loan and must not depend on the portfolio it is added to.  It reduces complexity by allowing the analysis to focus on the specific loan or investment while avoiding the need to take account of portfolio composition or how it influences that composition.  It reduces the calculation of minimum regulatory capital to a simple additive process once risk weights have been determined.  It allows the framework to apply to a wide range of countries and institutions, which facilitates agreement in a highly political context (Single Global Risk Factor)  It involves building a system for the calculation of capital requirements that systematically fails to reflect the importance of diversification as an influence on portfolio risk.  The minimum capital requirements associated with any type of loan due to credit risk simply rise linearly with the holding of that asset type, regardless of the size of the exposure.
  60. 60. The Rules of Basel II Provide a Government Stamp of Approval and Can Substitute for Management Judgment  Pillar 2 accords great discretion and authority to supervisors . . .  Supervisors are not auditors and are not participants in the business environment.  Supervisors have the authority to obtain any information they need from the supervised institution, but they don’t know what to ask for.  They are not well paid by the standards of senior bank executives and limited in their access to resources.  Supervisors are poorly placed to question the judgment of bank management so long as the objective minimum standards are met.  This makes it easy for explicit capital requirements formulas of the first pillar to dominate the supervisory judgment foreseen as part of the second pillar.  Senior Management of banks can be tempted to delegate responsibility for what should be management judgment by treating regulatory requirements as satisfactory targets for which supervisors could be held responsible.
  61. 61. The Revised Framework is pro-cyclical and can Exaggerate Booms and Busts Rising profits in the upswing usually generate increases in retained earnings and hence Tier 1 Capital, and prudent banks, ideally, should use these to build a cushion to see it through the downswing which inevitably follows. More specific factors include:  If asset values do not accurately reflect future cash flows, pro- cyclicality results. Leverage ratios depend on current market values (and are therefore high in good times and low in bad times).  Banks’ risk measurements tend to be point-in-time and not holistic measures over the whole cycle.  Counterparty credit policies are easy in good times and tough in bad,  Profit recognition and compensation schemes encourage short- term risk taking, but are not adjusted for risk over the business cycle.  Capital Regulation under Basel did nothing to counter this pro- cyclicality.
  62. 62. Capital Requirements for Banking Subsidiaries May not be Adequate at Group Level  Basel II is to be applied on a consolidated basis to internationally active banks to ensure that it captures the risk of the whole banking group. It is not clear this works well since:  Wide scope exists for parent groups to maintain high levels of capital in depository subsidiaries by simply shifting funds within the group  Parent groups are often less well-capitalized than their subsidiary depository institutions  Large balance sheet expansions have occurred at both banking subsidiary and parent group levels without requiring meaningful increase in capital at the parent group level.
  63. 63. Subjective Inputs  Risk inputs are subjective.  Some prices are of the over-the-counter variety and are not observable, nor do they have appropriate histories for modeling purposes. Banks can manipulate inputs to reduce required capital.
  64. 64. Unclear and Inconsistent Definitions of Capital  Regulatory adjustments for goodwill are not mandated to apply to common equity, but are applied to Tier 1 and/or a combination of Tier 1 and Tier 2.  The regulatory adjustments are not applied uniformly across jurisdictions opening the way for further regulatory arbitrage.  Banks do not provide clear and consistent data about their capital. This means that in a crisis the ability of banks to absorb losses is compromised and different between countries – exactly as seen in the crisis.
  65. 65. Supervisors Have Not Been Known To Be Forward Looking.  Building capital buffers under Pillar 2 (Stress Testing, . . . ) requires supervisors to be forward looking., that is, to keep up with changes in market structure, practices and complexity. This is inherently difficult.  Supervisors may be even less likely to be able to predict future asset prices and volatility than private bankers.  Supervisors have smaller staff (per regulated entity).  Supervisors are mostly less well paid.  If supervisors practices lag the policy makers will be ineffective in countering defects in Pillar 1. Pillar 2 is not likely to be effective in a forward-looking way.
  66. 66. Markets Just Aren’t Efficient  Pillar 3 relies on disclosure and market discipline that will punish banks with poor risk management practices. Underlying this is an efficient markets notion that markets will act in a fully rational way.  At the level of markets, the bubble a the root of the sub- prime crisis, and crises before it, suggest the systematic absence of informational efficiency.
  67. 67. Strengthen the Global Financial System by: 1) Raising capital Requirements, 2) Increasing Capital Levels, 3) Improving Risk Management Practices, and 4) Expanding Disclosure. Basel III
  68. 68. Improving the Quality of Capital  Equity is the best form of capital, as it can be used to write off losses.  Goodwill. This can’t be used to write off losses.  Minority Interest. That if a company takes over another with a majority interest and consolidates it into the balance sheet, the net income of the 3rd party minorities can’t be retained by the parent as common equity.  Deferred Tax Assets (net of liabilities). These should be deducted if they depend on the future realization of profit (not including tax pre- payments and the like that do not depend on future profitability)  Bank investments in its own shares  Bank investments in other banks, financial institutions and insurance companies.  Provisioning shortfalls  Other Deductions. Projected cash flow hedging not recognized on balance sheet that distorts common equity; defined benefit pension holdings of bank equity; some regulatory adjustments that are currently deducted 50% from Tier 1 and 50% from Tier 2 not addressed elsewhere.
  69. 69. The Proposed New Basel III Framework  Minimum Common Equity: The highest form of loss- absorbing capital, this threshold will be set at 4.5% of risk- weighted assets.  Tier 1 Capital Requirement will be set at 6%.  Total Capital Requirement will be set at 8%.  For each category, there will be a 2.5% Conservation Buffer to absorb losses during periods of financial and economic stress. If an institution “uses up” the conservation buffer and approaches the minimums, it will become subject to progressively more stringent constraints on dividends and executive compensation (. . . Until the buffer is replenished).  Minimums will be phased in between January 2013 and January 2015, and the conservation buffer will be phased in from January 2016 to December 2018. Raise Min. Core Tier 1 to 4.5%+ 2.5% = 7%
  70. 70. The Proposed New Basel III Framework  A Counter-Cyclical Buffer (0% to 2.5%) also could be imposed by countries in order to address economies that are building excessive risks as a result or experiencing rapid economic (i.e., credit) growth. It must consists of fully loss-absorbing capital.  In addition to raising the capital requirements, Basel III imposes more criteria in order for instruments to classify as common equity and to count as Tier 1 capital. Instruments that no longer will qualify as common equity will be excluded beginning in January 2013.  There will be higher capital requirements for certain trading, derivatives and securitization activities. These will be introduced at the end of 2011.  A liquidity coverage ratio (Liquidity Coverage Ratio, Net Stable Funding Ratio) will be introduced in 2015 and the net stable funding ratio will be applied starting in 2018.
  71. 71. Basel III Minimum Capital Requirements 0 1 2 3 4 5 6 7 8 9 10 11 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 2 0 2 0 2 0 2 1 2 0 2 2 3.5% 4% 4.5%4.5% 5.5% 6% 8% 8.625% 9.25% 9.875% 10. 5% Tier 1 Common Equity Other Tier 1 Capital Other Capital Capital Conservation Buffer % of RWA Year
  72. 72. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Equity Instruments that no-longer qualify as Tier 1 or Tier 2 Capital 0 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 2 0 2 0 2 0 2 1 2 0 2 2 Year (As of January 1st) Allowable recognition of instruments (% of outstanding nominal amounts at 1/1/2013 Phase in of the required regulatory adjustments of certain items in calculating common equity (% of full adjustment that will ultimately apply)
  73. 73. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Leverage and Liquidity Ratios 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 2 0 2 0 2 0 2 1 2 0 2 2 Leverage Ratio Net Stable Funding Ratio Liquidity Coverage Ratio Observation Period Observation Period Minimum Standards in Force Minimum Standards in Force Supervisory Monitoring Parallel Run Disclosure Migrate to Pillar 1
  74. 74. The Proposed New Basel III Framework  A non-risk-based leverage ratio will also be introduced in 2018. It is currently proposed that a minimum Tier 1 leverage ratio of 3% be tested during a parallel run period and then subjected to an appropriate review and calibration process, before migrating to Pillar 1 treatment.  Systematically Important Banks should have loss-absorbing capacity beyond these minimum standards: A combination of Capital Surcharges, Contingent Capital, and Bail-in-Debt. In addition to strengthening the loss-absorbency of non- common Tier 1 and Tier 2 Capital instruments.
  75. 75. Existed Way Before Basel Ever Did . . . Bank Capital
  76. 76. Back to the ABC of Bank Capital: The Good Old Days! It’s a Wonderful Life!
  77. 77. What is Bank Capital?  Is bank’s net worth, which equals the difference between total assets and liabilities.  Is a cushion against a drop in the value of bank assets, which could force a bank into insolvency.  Helps prevent bank failure, a situation in which a bank cannot satisfy its obligations to pay its depositors and other creditors.  Helps lessen the chance that a bank will become insolvent if its assets drop or devalue. How Linear is the Relationship Between the various Types of Assets, Liabilities, and Capital that a Bank is Allowed to Carry on Its Balance Sheet ?????? !!!!!!! Whatever Happen to Gap and Duration Analysis?
  78. 78. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Internal . . . Internal  The level of capital which the management of the bank thinks is appropriate, supported by an internal assessment of the capital at risk;  Based on the capital level, the second step would be setting of decent Return On Equity. This hurdle return would be based on market expectation, exceeding the market expectation will result in an increase in shareholder value whereas failing to meet those expectations will result in a destruction of value.
  79. 79. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > External . . . External  The level of capital which the credit rating agencies think is consistent with a given credit rating. No credit rating agencies will give assurance of up-grading or maintaining current rating solely based on capital adequacy, but indication can be obtained through discussion;  The regulatory capital. A margin of error needs to be built as regulatory capital shortfall can have very serious consequences. It will change with experience.
  80. 80. Why is Bank Capital Important?  The amount of capital affects return on investment for the equity holders (owners) of the bank.  Bank capital ends up costing the equity holders because higher capital reserves generate lower return on equity for a given return on assets.  The lower the bank capital, the higher the return for the equity holders of the bank.  Larger bank capital reserves benefit the equity owners of a bank because it makes their investment safer by reducing the likelihood of bankruptcy.
  81. 81. How Do Banks Raise Capital? Banks can raise capital by:  issuing new equity (common stock),  Issuing bonds that can be converted into equity,  reducing the bank’s dividends to shareholders, which increase the retained earnings that can be put into capital accounts.  Neither option is particularly appealing to existing shareholders because issuance of new equity dilutes their profits and reduction of dividends simply reduces their return on investment.
  82. 82. Role of Bank Capital Requirements in the Recent CRISIS and How Higher Reserves Could Have Averted Bank Failures  Higher bank capital reserves could have provided a means of satisfying obligations to pay off depositors and creditors as assets were lost or devalued due to risky investments  Capital is supposed to act as a first line of defense against bank failures and their knock- on consequences for systemic risk by providing a cushion against losses. Capital Serves One Economic Purpose: Absorb Potential Losses
  83. 83. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > The Basics: Types of Capital DEBT CAPITAL  What will be repaid if the bank go into liquidation  Subordinated to the bank’s depositors & lenders EQUITY CAPITAL  Fully paid ordinary shares  Non-Cumulative perpetual preferred shares
  84. 84. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 > Basel II Capital Structure, Ratios and Deductions CAPITAL STRUCTURE  Tier 1: Issued & fully paid for Ordinary Shares + Non-Cumulative Perpetual Preferred Stock + Disclosed Reserves + Innovative Tier 1 capital  Tier 2: Undisclosed Reserves + Asset Re- evaluation Reserves + general Provisions + general Loan Loss Reserves + Hybrid Capital Instruments + Subordinated Debt  Tier 3: Subordinated Debt for a minimum of two years (Used to support Market Risk) RATIOS BETWEEN THE TIERS OF CAPITAL  Tier 2 capital cannot exceed 50% of the total equity  Innovative instruments are limited to a maximum of 15% of Tier 1 capital (after deductions)  Lower Tier 2 capital (Subordinated Debt issues) may only equal up to 50% of core capital  The use of Tier 3 capital is limited to 250% of the amount of Tier 1 capital that is required to support Market Risk (28.5% of Market Risk should be covered by Tier 1)
  85. 85. Mohammad Fheili < mifheili@terra.net.lb > < Mobile: 00961 3 337175 >  ( - ) Goodwill: Tier 1 capital of the new bank (acquired plus acquiring bank) is less than that which the banks independently had before the acquisition.  ( - ) Investments in Subsidiaries: when it is not consolidated  ( - ) Holding of Shares in Another Bank: discretion of local supervisors Basel II Capital Structure, Ratios and Deductions
  86. 86. Components of Capital Components Minimum Requirements Core Capital (Tier 1) Common stockholders’ equity Qualifying, noncumulative, perpetual preferred stock Minority interest in equity accounts of consolidated subsidiaries Less: goodwill and other intangible assets Note: Tier 1 must represent at least 50 percent of qualifying total capital and equal or exceed 4 percent of risk-weighted assets. There is no limit on the amount of common shareholder's equity or preferred stock, although banks should avoid undue reliance on preferred stock in Tier 1. Banks should also avoid using minority interests to introduce elements not otherwise qualified for Tier 1 capital. Supplementary Capital (Tier 2) Allowance for loan and lease losses Perpetual preferred stock and related surplus Hybrid capital instruments and mandatory convertible debt securities Term subordinated debt and intermediate-term preferred stock, including related surplus Revaluation reserves (equity and building) Unrealized holding gains on equity securities Note: Total of Tier 2 is limited to 100 percent of Tier 1 ALLL limited to 1.25 percent of risk-weighted assets Subordinated debt, intermediate-term preferred stock and other restricted core capital elements are limited to 50 percent of Tier 1 Deductions (from sum of Tier 1 and Tier 2) Investments in unconsolidated subsidiaries Reciprocal holdings of banking organizations’ capital securities Other deductions (such as other subsidiaries or joint ventures) as determined by supervisory authority Any assets deducted from capital are not included in risk-weighted assets in computing the risk-based capital ratio Total Capital (Tier 1 + Tier 2 - Deductions) Must equal or exceed 8 percent of risk-weighted assets
  87. 87. New Basel Capital Requirements Old Standards New Standards Amount  Includable in  Total Capital Elements of Capital No Limit Tier 1 •Common shareholders’ equity •Non‐cumulative perpetual preferred •Minority interests in consolidated  subsidiaries  Includible  Only  Up to  Amount of  Tier 1 Tier 2 Amount Includible  In Tier 2 Capital  •Cumulative preferred  (perpetual or long‐term) •Long‐term preferred •Convertible preferred No Limit •Intermediate‐term  preferred •Subordinated debt •Debt‐equity hybrids,  including perpetual  debt Only Up to 50% of  Tier 1 Amount  Includable in  Total Capital  Elements of Capital  No Limit  Tier 1  •Common shareholders’ equity •Additional Going Concern Capital (common shares and retained earnings) No Limit Tier 2  •Minority interests in consolidated subsidiaries •Cumulative preferred (perpetual or long‐term) •Long‐term preferred •Convertible preferred • Intermediate‐term preferred •Subordinated debt •Debt‐equity hybrids, including perpetual debt
  88. 88. The Million Dollar Question Can Bank Capital Regulation Prevent Future Financial Crises?
  89. 89. Bank Regulation: Proposed Changes to Corporate Governance
  90. 90. Introduction: Why Change Corporate Governance?  Proposed changes to the internal structure of corporations can be divided into three primary categories: 1) Shareholder Empowerment 2) Disclosure Requirements 3) Executive Compensation  The latter two frequently appear as measures designed to empower shareholders
  91. 91. The Corporate Structure of a Bank  The corporate structure of banks is divided into three branches: Shareholders, Directors, and Managers  Shareholders are the equity holders, or owners, of the corporation, and can be divided into two types: 1) Diffuse shareholder: small, or minority shareholders  Vote for directors  Vote on matters including mergers and acquisitions, or other fundamental changes in business strategies (albeit indirectly through board member elections) 2) Concentrated shareholder: large, sometimes institutional, investors  Occasionally elect their own representatives to the board of directors,  Can negotiate incentive packages to align management interests with that of shareholders
  92. 92. The Corporate Structure of a Bank: Board of Directors  Board of Directors: besides making employment decisions and monitoring management, directors in banking firms have further responsibilities beyond mere fiduciary duties: 1) Ensure the bank’s activities are in the best interest of not only the shareholders, but depositors as well as the government (taxpayer) 2) Abide by laws and regulations reflecting the government's interest in maintaining safe and sound financial institutions  Other responsibilities of bank boards of directors include: 1) Select competent management 2) Supervise the bank’s affairs 3) Adopt sound policies and goals under which management must operate in the administration of the bank’s affairs 4) Avoid self-serving practices 5) To be informed of the banks position and management policies 6) Maintain reasonable capitalization 7) To ensure the bank has a beneficial influence on the economy and the community in which it rests  The board also oversees the level and structure of top executive compensation; this duty is perhaps the most critical in aligning the interests of management with that of shareholders
  93. 93. The Corporate Structure of a Bank: Managers, (Focus on CEO)  The CEO is responsible for running the bank on a daily basis;” the CEO: hires, fires and leads the senior management team, who “in turn, hires, fires and leads the other employees in the organization;”  “Develops, along with the board of directors, the bank vision and sets the strategic direction for the bank  “Establishes, more than any other individual, the control culture for the organization  “Oversees the development of the bank's budget and the establishment of the bank's system of internal controls”  Ultimately, the goal of management is to formulate a business plan that incorporates and oversees financial, administrative and risk functions in order to maximize the firm’s value  Public responsibilities
  94. 94. Managers & Compensation  Managers are paid a contracted salary, and frequently a performance measured bonus; compensation can be either in the form of cash or stock options, though usually both  As mentioned before, top management salaries are structured by the board of directors; however, some consideration include: 1) Capital structure 2) Capital reserves  Compensation and risk: boards have the responsibility of balancing the firms ability to recruit and retain management talent while maintaining appropriate risk management systems  Aligning executive compensation with the company’s long- range objectives  Certain business risks may present opportunities for managers driven by short-term incentives (e.g. stock price or earnings per share)  These metrics can be manipulated, for example, by management decisions related to revenue and expense recognition or through stock buybacks at the end of the period
  95. 95. Failure within Corporate Governance • The lingering financial problems with the 2007-08 crisis stem from shaken investor confidence in the markets, the result primarily of excessive risk- taking on the part of managers, enriching themselves via short-term bonuses while destroying the long-term value of their firms — Moral hazard — Consider also that in 2008, 70% of shares in financial institutions were owned by institutional investors, thus, this was not merely a matter of unsophisticated investors being taken advantage of by large, complicated banking firms • Shareholder disempowerment: firms have grown “director-centric”
  96. 96. Failure within Corporate Governance  Personal response: the failure of corporate governance comes primarily from two sources: 1) Failure on the part of boards of directors and managers of many financial institutions to adequately manage or react to the risk surrounding the types of products these firms were selling to investors 2) Second, shareholders have become detached from the boards of firms in ways that make monitoring and oversight, even for sophisticated investors, difficult
  97. 97. Corporate and Financial Institution Compensation Fairness Reform  Finally, the Bill directs federal regulators to craft regulation that requires financial institutions to disclose the structures of incentive based compensation sufficient to determine whether it is: 1) Aligned with sound risk management 2) Structured to account for time horizon of risk 3) Reduces incentives for employees to take unreasonable risks  The goal is to regulate compensation structures or risk incentives that may: 1) Threaten the safety and soundness of covered financial institutions 2) Present serious adverse effects on the economy or financial stability
  98. 98. The Pros and Cons of Corporate Governance Reform  Pros:  Moral hazard incentive problems  Despite decreases in market capitalization between 2003-2008, several top Wall Street firms paid out an aggregate $600 billion, giving the impression that compensation packages are not in line with the best interest of shareholders  Cons:  Zingales: “While popular, actions directly aimed at curbing managerial compensations would be completely useless if not counterproductive, just as the 1992 Clinton initiative to curb managerial compensation had the opposite effect”; Rather, he continues, “[the] real issue is the lack of accountability of managers to shareholders, centered in the way corporate boards are elected”  Micro-managing compensation  Keeping talent  Shareholders tend to be detached from the everyday management of corporations
  99. 99. Credit Rating Agencies
  100. 100. Background  3 Biggies – Fitch, S&P and Moody’s  Others in US  Basel’s list of internationals  History  Generally good  Last decade of criticism mounting  Current attack  Completely wrong on new securities (standards/duty)  Conflicts of interest
  101. 101. What They Do  Issue Rating  Once upon a time paid for by investors, now paid for by issuers of the securities  Used as a way to lower cost for investors  Theoretically increase market efficiency  Increase market information  Increase liquidity for smaller size issuers/less well known securities  Rating reflect:  Company’s ability to repay debts  Structure of the instrument  Subordination of the security
  102. 102. What They Do . . .  Uses of Credit Ratings  Most issues of bonds need at least one rating in order to increase their marketability  Avoid under-subscription or low initial purchase price  Many lenders use credit ratings as covenants in loans  Defaults can be triggered by a drop in the borrower’s credit rating
  103. 103. What They Do . . .  Advisory Services  Advise issuers on how to structure instruments in order to obtain the maximum yield  Use of covenants and subordination  Structured Financing - form trenches using definitions in the transaction documents  Advise companies on formation of Special Purpose Vehicles to maximize their credit ratings
  104. 104. What They Do . . .  Advisory Services create lowest possible quality at each rating level (regulatory arbitrage-type pattern) • Obvious conflict of interest in rating issuances and SPV’s which they advised during formation oFeel an obligation to rate as promised o Very few rating agencies have a policy of not rating projects they have advised on
  105. 105. Regulatory Reliance . . .  Basel II – recognized ratings from External Credit Assessment Institutions (ECAI’s)  Allows regulators worldwide to use ratings from ECAI’s in order to determine reserve requirements  Insurance Regulators – Use credit ratings to evaluate insurance companies’ reserves
  106. 106. Regulatory Structure
  107. 107. General Increase in Government Intervention • Safety Nets • Bail outs • Deposit insurance • Discount windows Decrease industry stability
  108. 108. General Increase in Government Intervention • Regulations • Heightened Supervisory Power • Requires market discipline • Improves corporate governance • Improves bank function
  109. 109. General Increase in Government Intervention • Increase market discipline • Increase cost efficiency • Increase profit efficiency • Reduce asymmetric information • Reduce transaction costs • Decrease stability • Economies of scale in compliance costs • Discourage entry of new firms • Consolidation into larger banks • Reduction of competition
  110. 110. General Increase in Government Intervention  Increased Regulation requires increased information disclosures  Information disclosures are costly  Compliance is expensive
  111. 111. Thinking Beyond Basel III Preparing For The Next Crisis
  112. 112. Basel III designed in Swiss style. *A committee has been set up to discuss the benefits of using a Mark to “how you feel today” accounting. methodology” instead of Mark-to- market Surrender monkey says: systemic risk has a hole new flavor 9 years for implementation No discussion of too big too fail Counter cyclical buffers can be 0%No accounting reform or harmonization*
  113. 113. The Rear View Mirror  • The past 3 years have been unprecedented:  Failure of numerous large institutions across the globe  Large-scale government support of the financial system  Coordinated economic stimulus activity  Record low interest rates  Regulatory reforms  The above promotes the need to continually strengthen risk management capability, however, it also highlights the possible inadequacies historically
  114. 114. Learning from the past – ‘Rogue Trading’  During 2008, Societe Generale reported a loss of €4.9bn due to a number of unauthorized trades In 1995 Barings collapsed after a Nick Leeson, a trader in Singapore generated losses of £900m through a series of rogue trades, caused by serious control failures And another And another This did not stop the following…
  115. 115. Expecting the unexpected The last few years have seen the demise of significant local, national and global financial services firms…but what caused these trusted brands to fail?
  116. 116. Complexity of business failures  Often, there will be numerous factors that lead to the collapse of an organization e.g.  Inappropriate business model  Inadequate systems and controls  Poor oversight and governance  External influences  The interlinked nature of risks requires an appreciation of all risk types, . . .
  117. 117. Key Challenges for the Future of the Financial Service Industry  • Continued economic uncertainty  Impact of unraveling the Quantitative Easing program  Rising interest rates / inflation  Double-dip recession  Regulatory developments  The Walker Review on Corporate Governance  Capital regime reforms  Solvency II  Basel III  Retail Distribution Review
  118. 118.  • Regulatory supervision  Intensive / intrusive supervision of larger firms  Greater focus on individual responsibilities and accountabilities of senior management  High profile enforcement action / fines  A return to the pre-credit crisis practices  Risk v Reward not adequately monitored  Fewer market participants = greater opportunities Key Challenges for the Future of the Financial Service Industry
  119. 119. What Does this Mean for Risk Managers?  Risk managers will need to adopt the CRO perspective  Appreciation / awareness of other risk categories – multi- discipline approach  Understand consequential impacts across risk categories  Greater depth / breadth of industry knowledge   Greater profile for risk management in Financial Service firms, however, this equates to higher expectations  Need to instigate change before regulators impose their requirements  Increasing need to access and influence senior management  Increasing focus on risks within the business model  Increasing importance on personal skills, credibility and persuasiveness
  120. 120.  Greater scrutiny of risk functions and risk managers  Demonstrating success  Increasing demand for skilled individuals with appropriate knowledge and experience…and qualifications! What Does this Mean for Risk Managers?
  121. 121. Who Is The Supervisor? Who Is The Banker?

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