1-
The basel committee
2- Basel I
3- Basel II
3-
BASEL II
•
Introduction
• The pillars of Basel
II
• Basel II, what consequences
for firms?
• The impact of Basel II
on western markets of securitization
• The pillars of Basel II
Basel II recommendations rely on three pillars:
- pillar I: the demand of equity (solvency
ratio McDonough):
It is mainly a banking ratio but it is more precise than the
ratio Cooke for it takes into account the risk more or less
high of the various loans granted by a financing establishment
and fix a limit to the balanced outstanding of the loans granted
by the financial establishment depending on its equity. The
level of commitment from banks is then limited by their own
financial solidity. This ratio enables to set up the cautious
arbitrage.
It refines the 1988 Bâle I Agreement and wants to make
the equity coherent with the risks truly incurred by financial
establishments. Among the novelties, there are the operational
risks (fraud and system breakdown) and market risks, in addition
to credit and counterparty risk.
We then go from the ratio Cooke where (Bank equity >8% of
credit risks), to the ration McDonough where (Bank equity >8%
of the credit risks (75%) + market risks (5 %=) + operational
risks (20%).
Those credits are formulated thanks to probabilities that apply
on the one year outstanding of the customer: the DTD (display
at the time of defect):
For the credit risk, banks can use different mechanisms of evaluation:
• The « standard » method that consists in
using rating systems provided by external organisms. In this
method, DP and LGD are imposed by the regulator (bank’s
commission in France) directly from the DP or by the JGD, or
by imposing a rating organism.
• The « sophisticated » methods (method IRB
for Internal Rating Based) with the IRB-Foundation method and
the Advanced-IRB method which involve internal methodologies
and peculiar to the rating financial establishment of evaluation
of the quotations or marks, in order to measure the relative
risk of the credit. In the IRB-Foundation method, the bank estimates
that its DP and the LGD still have to be imposed by the regulator.
In Advanced-IRB method, the bank controls all its components.
The choice of the method by a bank (more or less complex) enables
the identification of its own risks according to its management.
The bank that would like to closer to reality will tend to choose
an advanced method. But in return, the investment is even more
important: the calculation of a LGD requires the management
and the historicizing of more then 1500 monthly data on a minimum
of five years on each granted credit.
The determination of the credit risk is then simple:
RWA= f x (PD; LGD) x EAD
Where « f » follows a normal law
It is completed by the calculation of an expected loss: EL =
PD x LGD x EAD
In the ratio McDonough: Equity taken into account / (Credit
risk + Market risk) > 8%.
The sum of the RWA of each customer will compose the credit
risk, ad the EL will be modified by the rules of supplying of
equity.
- pillar II: The surveillance procedure of
the management of equity:
The financial strategies of banks vary according to the composition
of the asset and the risk-taking, which means that the central
banks will have more freedom in the setting up of norms toward
banks; they could increase the capital demands when they find
it necessary. This rule will enable to face the various financial
strategies of banks: composition of their asset, risk-taking…
In fact, this part helps examining the essential principles
of cautious surveillance and it includes recommendations about
the management of risks as well as the transparence and the
cautious responsibilities.
This necessity will be applied according to two ways:
- Validation of the statistic methods used in the pillar I (back
testing) where the bank will have to prove a posteriori the
validity of its methods defined according to its statistic data
and this on quiet long periods (from five to seven years). It
will also have to be able to «draw » the origin
of its data.
- Validity test of the equity in case of an economic crisis
where the bank will have to prove that on its customers’
segments, its equity is enough to bear an economic crisis affecting
one or all the sectors.
Indeed, the banking commission will be able, according to its
results, to impose the necessity of additional equity.
- pillar III : The market discipline :
The enforcement of Basel II is a powerful machine that «format
» the management data of a bank. Rules of transparency
are established toward the information for public use on the
asset, the risks and their management. Its consequences consist
of three orders for the pillar III:
1) Standardisation of the good banking practices: whatever the
bank and the regulation that governs it (national rights), the
practices have to be transparent and standardised.
2) The setting up of the data for this calculation that are
a powerful source of management data, which (finally) reconcile
the risky, countable and financial views.
3) Financial transparency: the analysts will finally find a
reading for the portfolios of similar risk for any bank in the
country.
These recommendations are translated into the legislations of
the member states. The Basel accords are currently applied in
more than a hundred countries. The Basel II Agreement is completely
applied in the European Union from January, 1st, 2007.
