David Uren, Economics correspondent | *July 21, 2008* Article from: The Australian <http://www.theaustralian.news.com.au/>
*WHAT role did banking regulators play in the financial crisis still sweeping the globe?* A primary cause _ according to the OECD's deputy director of financial markets, Adrian Blundell-Wignall. Completely peripheral _ according to Australia's chief banking regulator, APRA chairman John Laker. The two crossed swords at the Reserve Bank of Australia's Kirribilli private retreat last week, where Laker was discussing a presentation by Blundell-Wignall. Blundell-Wignall is one of the most creative thinkers about financial markets and is widely respected for the chillingly accurate portrayal of how the crisis would unfold _ which he delivered last July, a few weeks before the storm broke. He is a former senior economist at the RBA, to which he still has strong links. Blundell-Wignall fingers two regulatory causes for the crisis: the announcement of the details of how the bank capital regulatory system, Basel II, would work in July 2004 and, paradoxically, a regulatory crackdown on the operations of US mortgage funders Fannie Mae and Freddie Mac in the same year. The first, he says, made it a lot more attractive for banks to enter the mortgage business, while the second cleared the principal competition from the field. There were other contributors. Slack monetary policy flooded markets with liquidity and the ratings agencies failed to provide objective advice because they were being paid by the issuers of securities, not by the investors. Others have made these points, but Blundell-Wignall's identification of regulatory causes is new. The first international agreement on bank capital requirements, Basel I, which was introduced in 1988, imposed an 8 per cent capital charge on assets, with half the capital to consist of equity. This led banks to securitise high-quality assets to get them off their balance sheets, and was seen to result in a lowering of the quality of bank balance sheets. Basel II had several innovations. It gave mortgages a favourable risk weighting of 35 per cent, while lending to companies rated AA- or above was weighted at 20 per cent. Moreover, banks that could satisfy their regulator that they had sophisticated risk management models were allowed to set their own capital allocations against different assets. According to Blundell-Wignall, the latter provision was like asking Bluebeard to return Queen Isabella's gold to Lisbon. Banks, he says, cannot be trusted to self-regulate their capital requirements. He says there are other problems with Basel II. It says the capital to be set aside should depend solely upon the use to which the loan is being put, and makes no allowance for the clustering of risk in portfolios. Basel II required banks to provide some capital for off-balance sheet exposures. Blundell-Wignall says this encouraged off-balance sheet exposure to be concentrated in products with low capital weighting. He says Basel II also encourages pro-cyclical risk taking, with the scope it allows for judgment resulting in risks being under-estimated in good times and over-estimated in bad. Laker was not convinced. The Financial Stability Forum, which is developing the global response by banking regulators to the crisis, has strongly endorsed the Basel II regime, and Laker is proud of Australia's early introduction of it. He argued that the incentives under Basel II were to lend to mortgages and keep them on balance sheet, whereas the experience was a surge in securitisation. He said Blundell-Wignall's analysis did not explain why there was the concentration in sub-prime lending. He argued that capital was not a binding constraint on US banks during this period, when most had surplus capital. He said it was implausible that the mere announcement of capital rules that were not due to become mandatory until 2008 would have such an effect on market development. If the announcement of Basel II had been such an important influence on the growth of mortgage lending, then why had it not had the same effect in Australia, or other countries. Blundell-Wignall argues there were other components to the cocktail in the US, particularly monetary policy; however he says the influence did spread beyond the US. Indeed, it is the run on Northern Rock in Britain that provides the best evidence for Blundell-Wignall's case. Less than a month before its fatal run, Northern Rock received approval from the British banking regulator, the FSA, to set its own capital requirements under Basel II. Asked why he had lifted the dividend at the expense of the balance sheet after issuing a profit warning just before the crisis struck, Northern Rock managing director Adam Applegarth replied: ``Because we had just completed our Basel II 2-year process and under that, and in consultation with the FSA, it meant we had surplus capital and therefore that could be repatriated to shareholders through increasing the dividend.'' Throughout the 2-year period when the bank was preparing for Basel II, it was increasing its lending as rapidly as 28 per cent a year. When the crisis struck, it had total assets of 113.4 billion but shareholders equity of only 2.2 billion. Under Basel II, the ``risk-weighted'' assets were only 18.9 billion and the bank appeared to have a strong capital buffer. ``These mechanisms of preparing for Basel II and concentrating in mortgages played a key role in some of the banks that suffered huge losses,'' said Blundell-Wignall. Laker had no quarrel with the second proposition of Blundell-Wignall: that increased capital requirements imposed on the mortgage giants Fannie Mae and Freddie Mac had contributed to the crisis. As Enron was filling the US headlines, the two lenders had been caught with some questionable accounts. They have their own regulator, distinct from the US banking regulator. It required them to maintain a capital level at least 30 per cent above the minimum requirement. Until they were forced to cut back, it had been difficult for private US banks to make much headway in mortgage markets because the two quasi-government financiers could always raise funds more cheaply. Blundell-Wignall argues it is important to have a single regulator, as does Australia, covering market integrity and consumer protection. He also maintains there is a need to ring-fence supervised banking activities, which enjoy lender of last resort, from investment banking and institutional banking, with their web of counter-party relationships. Several participants at the conference thought it would not be possible to achieve such a separation given the complexity of banking, even if it were desirable. There was a defensiveness, with some suggesting Blundell-Wignall was putting too much blame on the regulators, while it was the private sector that had taken the excessive risk. However, his analysis highlights a risk that, in entrusting the regulatory response to the crisis to the existing banking regulators, hard questions of their own culpability will be ducked. ---------- Forwarded message ---------- From: moony fouad <[email protected]> Date: 2009/4/13 Subject: {Kantakji Group}. Add '4103' Basel II and the financial crisis To: Salam Allah 3aliekom ,,, hereunder some points of view about basel and it's role in the financial crisis ,,, Mouna *'Basel Committee initiatives in response to the financial crisis'* A.H.E.M. Wellink, president van de Nederlandsche Bank In formulating responses to the financial crisis, it is necessary to address both the near term challenges related to the weakening economic and financial situation and the long term regulatory structure issues. The two are linked and we need to manage carefully the transition from current measures to a more sustainable long term framework. With regard to the near term situation, it is clear that the banking sector has been at the heart of the adverse feedback loop between the financial and real side. We have moved from what I would call the mark-to-market and illiquidity phase of the crisis related to legacy assets to the fundamental credit cycle part of the crisis. This is associated with large write downs from corporate and retail lending books, and I believe this phase will continue to play out over the medium term. It is critical that supervisors have a comprehensive strategy to deal with both phases of the crisis and their associated impact on banks. That is essential if we are to restore stability to our financial systems and economies. When it comes to the long term, we need to establish a clear target for the future regulatory system which substantially reduces both the probability and severity of a crisis like the one we currently are working though. By providing clarity about the future regulatory framework, we will help re-establish near term confidence, reduce the risk of competitive distortions and limit the degrees of uncertainty for the public and private sector. Also, by emphasising that these reforms will be phased in over an appropriate horizon, we reduce the risk that our own actions contribute to procyclicality in the system. In this regard our plans are closely aligned with the views expressed in the de Larosière Group’s report. This group’s report has been strongly appreciated by the Basel Committee. Let me now say a few words about the steps the Basel Committee has and will be undertaking to produce a more robust supervisory and regulatory framework for the banking sector. Such a framework needs to have four key components: 1. Strong regulatory capital, 2. Robust standards for bank liquidity, 3. Enhanced risk management, governance and supervision, and 4. Better transparency I would like to say a few words about each of these components. Regulatory Capital The Basel Committee, in a press release issued on March 12th following its recent quarterly meeting, underscored the importance of a strong capital base as a necessary condition for a strong banking sector. It stated that the level of capital in the banking system needs to be strengthened to raise its resilience to future episodes of economic and financial stress. The Committee will do this through a combination of initiatives, which I will describe momentarily. Our press release also noted that the Committee will review the regulatory minimum level of capital, taking account of these initiatives. Our objective will be to arrive at a total level and quality of capital that is higher than the current Basel I and Basel II frameworks and appropriate to promote the stability of the banking sector over the long run. This effort will be phased in over a time frame that will not aggravate the current stress. Building on the three pillars of the Basel II framework, we need to develop a more resilient capital framework that has multiple safeguards built into it. First, we need to improve risk coverage. One of the most procyclical dynamics has been the failure of risk management and capital frameworks to capture key exposures in advance of the crisis. For example, risks arising from securitisation activities – especially so-called resecuritisations – as well as certain trading book exposures were not sufficiently captured. I could also point to exposures to complex financial instruments that experienced severe declines in value because of impaired liquidity. The Basel Committee’s response therefore is to enhance the Basel II framework so that risks are more comprehensively and more accurately covered. Second, there needs to be a solid capital base backing these risks. We will achieve this by strengthening the quality, consistency, and transparency of the highest forms of Tier 1 capital. It must be based on a clear definition of capital that needs to be transparent and it must be global to ensure competitive equality. The Basel Committee already has a strong foundation for such a definition, namely common equity and reserves. We now need to deal with the many differences related to definitional issues, such as deductions from capital and the treatment of prudential filters. Third, we need to address procyclicality. Procyclicality is a complex issue and it is the product of many factors. At the most basic level, it is the result of animal spirits, which produce exuberant behaviour in the upswing of the cycle, and fear during the downturn. We cannot change this behaviour, but we can seek to dampen the channels through which it manifests itself. These include accounting and capital frameworks, liquidity regimes, risk management and compensation, margining, basic infrastructure, transparency, and the way supervision is carried out. In the case of the regulatory capital regime, we need to address any excess cyclicality in minimum requirements over the credit cycle while maintaining appropriate risk coverage and sensitivity. The Basel Committee has put in place a process to systematically assess the quantitative impact of Basel II on the level and cyclicality of capital. We will take appropriate steps if the results of our capital monitoring suggest the capital framework is unduly procyclical. But even more importantly, we need to build countercyclical buffers into capital frameworks and provisioning practices. This will help ensure that reserves and capital are built up during periods of earnings growth, so that they can be drawn down during periods of stress. The Committee is working to translate this important principle into a concrete proposal. The approach needs to have robust standards that can be applied at the global level and translated into national contexts. Finally, the capital framework needs to be underpinned by a non-risk based supplementary measure. This is particularly important as the Basel I-based floors are phased out. Just like we expect banks to manage to a variety of measures when they assess risk (such as net and gross exposures, VAR and stress tests), we as supervisors also must not constrain ourselves by evaluating risk through the lens of a single, risk based measure. We need the risk based measure to interact with a simple metric that can act as a floor and help contain the build up of excessive leverage in the banking system, one of the key sources of the current crisis. The Basel Committee is working to develop by year end a specific proposal in this area. Key principles guiding this work are that the measure must be simple and transparent, and it must address issues related to accounting differences and off-balance sheet exposures, among others. Finally, it needs to interact with the risk based measure in a prudent but sensible manner. Once these different streams of work are further advanced, taken together they will form the basis for the Committee’s assessment of the appropriate level of minimum capital that should be put in place over the long term. But whatever we do – and this gets back to my link between the near and long term – we must not raise global capital requirements in the middle of this crisis. Capital buffers are there to be used and we must provide a clear road map where we are headed. Liquidity Let me now say a few words about our work on liquidity. Capital is a necessary condition for banking system soundness but by itself is not sufficient. Of equal importance is a strong liquidity base. Many banks that had adequate capital levels got into trouble because they did not manage their liquidity in a prudent manner. In response to these shortcomings, the Basel Committee last September issued its Principles of Sound Liquidity Risk Management and Supervision. This was a significant step toward setting a new global soundness standard for what constitutes robust liquidity risk measurement, management and supervision. But this was only the first step. The next step is to monitor implementation of the principles and we have put in place a process to do just that. We also are developing benchmarks, tools and metrics that supervisors can use to promote more consistent liquidity standards for cross-border banks. Better risk management and supervision I have discussed the importance of having stronger global standards for capital and liquidity, but this is not enough. If firms have poor governance and risk management cultures or if supervision is weak, then we could again find ourselves with the types of problems we are now facing. We propose to build on Basel II’s supervisory review process – Pillar 2 – to raise the bar for risk management and supervision practices. This past January, the Basel Committee published for comment supplemental Pillar 2 guidance. The purpose of this guidance is to address the flaws in risk management practices revealed by the crisis, which in many cases were symptoms of more fundamental shortcomings in governance structures at financial institutions. The Committee will strengthen its supervisory guidance and the links to the Pillar 2 review process. It is focusing on firm-wide governance and risk management; capturing the risk of off-balance sheet exposures and securitisation activities; more effectively managing risk concentrations; and providing incentives to better manage risk and returns over the long-term, including compensation practices. Moreover, we need to move towards a macroprudential approach to supervision. What does this mean? In our discussions in the Basel Committee, we have emphasised the need to focus supervision not just on the soundness of individual banks but on broader financial stability objectives. This should inform where we focus our limited supervisory resources and how we develop our supervisory and regulatory tools. Transparency One of the main amplifiers of the crisis was the lack of transparency regarding the risk profile of institutions and structured products. Moreover, the process by which these products are valued often lacks rigour. Lack of transparency about the risk profile of products and financial institutions caused a massive retrenchment by investors and counterparties further amplifying the deleveraging process. To help mitigate this behaviour, the third pillar of the Basel II framework – market discipline – sets out a series of required disclosures that are intended to complement the other two pillars of the Basel II framework. This should allow market participants to assess capital adequacy of a bank through key pieces of information on the scope of application, capital, risk exposure and the risk assessment process. The Committee’s January proposals for enhancing Pillar 3 are focused on disclosures related to securitisation, off-balance-sheet exposures and trading activities. We believe that these proposed enhanced disclosure requirements will help to avoid a recurrence of market uncertainties about the strength of banks' balance sheets related to their capital market activities. Conclusion Taken together the recent and planned initiatives of the Basel Committee should promote a more robust banking sector and limit the risk that weaknesses in banks amplify shocks between the financial and real sectors. Because our measures are far reaching and ambitious, they will need to be phased in over a reasonable timeframe. I should also note the invitation to join the Basel Committee that we have extended recently to the BRIC countries – Brazil, Russia, India and China – as well as Australia, Korea and Mexico. The expansion of our membership will help enhance the global reach and acceptance of our standards. The efforts of the Basel Committee need to occur in a broader context of achieving the right balance between the scope and depth of regulation. Failure to produce adequate regulation for other "bank like" activities means that we in the banking sector will just be “pushing on a string”, and the activity will simply migrate elsewhere. I therefore strongly welcome the activities of other bodies like the G20, the Financial Stability Forum and the Joint Forum to ensure that all sectors are subject to an appropriate degree of regulation, oversight or transparency commensurate with their systemic significance. The Committee will actively contribute to these other efforts. --~--~---------~--~----~------------~-------~--~----~ You received this message because you are subscribed to the Google Groups "Kantakji Group" group. To post to this group, send email to [email protected] To unsubscribe from this group لفك الاشتراك من المجموعة أرسل للعنوان التالي رسالة فارغة, send email to [email protected] For more options, visit this group at http://groups.google.com/group/kantakjigroup?hl=en سياسة النشر في المجموعة: - ترك ما عارض أهل السنة والجماعة. - الاكتفاء بأمور ذات علاقة بالاقتصاد الإسلامي وعلومه ولو بالشيء البسيط. ويستثنى من هذا مايتعلق بالشأن العام على مستوى الأمة كحدث غزة مثلا. - عدم ذكر ما يتعلق بشخص طبيعي أو اعتباري بعينه. باستثناء الأمر العام الذي يهم عامة المسلمين. - تمرير بعض الأشياء الخفيفة المسلية ضمن قواعد الأدب وخاصة منها التي تأتي من أعضاء لا يشاركون عادة، والقصد من ذلك تشجيعهم على التفاعل الإيجابي. - ترك المديح الشخصي. -~----------~----~----~----~------~----~------~--~---
