Basel II: What's In It For You And Me?Category: Finance
Article added by: cesar magnaye
Come July 1st this year, the Bangko Sentral ng Pilipinas (BSP) or the country's central monetary authority will implement Basel II. I have yet to know of a local banker who is happy with Basel II. Most, if not all, of them consider it worrisome. In other parts of the world, risk managers say that the devil in Basel II is in the details, while other bankers consider it as banking's "challenge of the decade", no less.
Why care?
I must admit that Basel II is a topic that a layman would not normally waste time on. If I were working somewhere else other than a bank, maybe I wouldn't either. I took the effort to understand Basel II, even though I'm no longer in mainstream banking, because from time to time my work as a consultant requires me to provide technical assistance in some activities that have to do with it.
So what's in it that a layman should know about? Nothing in particular, but everything in general. You will probably agree with me that although something doesn't interest me or you doesn't mean that that something would not affect me or you in any way. That's the case with environmental issues: We can choose to ignore all the political and media noise surrounding climate change, but the long term threat on our way of life as we know it remains as real as the sun shining everyday. That's pretty much the same case with Basel II as far as it affects banking and the free market system which it underpins, from where we draw our everyday living.
So, what's it?
Let me try to keep it simple: Basel II is intended by banking regulators to strengthen the banking industry, and by so doing, protect the banking public. In the process of implementing Basel II, regulators also expect that banks' corporate governance will be strengthened and their disclosures, improved. These will be achieved by making regulatory capital requirements more risk-sensitive and reflective of most, if not all, of the risks that banks are exposed to.
In the Philippine case, the monetary authorities decided to embrace Basel II as a result of a confluence of events within and outside the country. Within, the BSP started getting concerned about the derivatives activities of banks in 1995 which greatly increased the risk exposure of the banking system. This led to the BSP changing its tack from mere financial audit and compliance review to risk measurement and management in its banking supervision thrust. Side by side with this move, the monetary authorities ensured that banks had sufficient buffer for risks in the form of capital which protects them from income volatility.
Outside, while these developments were unfolding within the country, an international effort was underway to align regulatory capital regulations to enable comparability in measuring financial strength, especially for banks with substantial international operations. This initially led to Basel I, which related capital requirements to credit risk. However, because of criticisms, among others, that the initial attempt to relate capital to risk was rather "crude" (i.e., not based on any measurement), the calls to revise Basel I gave birth to Basel II.
Problems and Opportunities
Let me skip the technical nuts and bolts of Basel II, like its three "pillars", etc. that is meant for hard-nosed bankers. In its place, I'd like to highlight a couple of items that might interest you even if your line of work doesn't take you anywhere near a bank everyday.
Since the flip side of every problem is an opportunity, the good place to start, therefore, are the problems being encountered or foreseen by banks as they gear up to comply with Basel II. Thus, if you happen to be a service provider or supplier, as the case maybe, who could present solutions you'd be on to something worth exploring.
Item 1: With the inclusion of specific capital requirements for credit derivatives, securitization exposures, counterparty risks in the trading book, and operational risks, I figure that some banks would, sooner or later, need additional capital infusion in either Tier-1 or Tier-2 format. This is obviously an opportunity for investment bankers.
Item 2: The challenge in risk-based capital assessment is how to measure risk accurately through time. Since this is new to most, except maybe the large global players, many banks are trying to solve this methodological problem by hiring experienced risk managers and then tasking them with developing this analytical capability in-house. Some others might outsource this skill. So, that's another opportunity both for individuals and entities that can provide such specialized services.
Item 3: Assuming the methodological problem can be managed, there could be impediments with regard to data availability. And even if data is available, three related issues come to the surface, namely: access, quality and process management. This is obviously an opportunity for IT service providers and suppliers.
(This is an edited version of the article published earlier at http://investmentbankeronlife.blogspot.com )
Posted By: cesar magnaye
Web: http://investmentbankeronlife.blogspot.com
Contact: e-mail
| About the Author: |
| Cesar Magnaye is a Filipino economist, corporate planner, and investment banker. He is presently a consultant to the Philippine National Bank and the Department of Finance. You can find his blog, "An Investment Banker's Take On Life", at http://investmentbankeronlife.blogspot.com. He also writes for the LendingClub.com blog. |
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