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Confidential – All rights reserved – Ernst & Young LLP 2005 Brian Boyle – Ernst & Young PRMIA Panel Discussion: Basel II Update September 26, 2005.

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Presentation on theme: "Confidential – All rights reserved – Ernst & Young LLP 2005 Brian Boyle – Ernst & Young PRMIA Panel Discussion: Basel II Update September 26, 2005."— Presentation transcript:

1 Confidential – All rights reserved – Ernst & Young LLP 2005 Brian Boyle – Ernst & Young PRMIA Panel Discussion: Basel II Update September 26, 2005

2 2 Confidential – All rights reserved – Ernst & Young LLP 2005Agenda Basel Refresher Basel II Regulatory Landscape Basel II Timeline Remaining Open Issues Current State of Industry Basel II: Other Challenges

3 3 Confidential – All rights reserved – Ernst & Young LLP 2005 Brief History 1988 Basel Accord: G-10 central banks agree to apply common minimum capital standards to banking industries Basel I not applied directly but through national or transnational rules (U.S.: Capital Adequacy Guidelines, EU directive: CAD or Capital Adequacy Directive) Basel I now applied to virtually all countries with internationally active banks (approx. 100 countries) 1996: Market Risk Amendment 2001: First Consultative Paper June 2004: “International Convergence of Capital Measurement and Capital Standards: a Revised Framework”

4 4 Confidential – All rights reserved – Ernst & Young LLP 2005 Basel II - Components of the Framework – Credit risk – Operational risk – Market risk – Banks review own capital adequacy – Supervisors evaluate bank assessments – Increased disclosure given reliance on internal assessments

5 5 Confidential – All rights reserved – Ernst & Young LLP 2005 Basel II Regulatory Landscape QIS 4 Undertaken on a best efforts basis by 26 U.S. banks in early 2005 and attempted to quantify the effects of the Basel II proposals on banks’ required capital levels Regulators noted that results indicated an unexpectedly large decline in overall required capital as well as a wider than expected dispersion of key parameter estimates by participating banks Aggregated QIS 4 results released by regulators as part of recent Congressional hearings on Basel II European Institutions European regulators have indicated that all three Basel II approaches (Standardized, Foundation and Advanced) will be permitted Parallel run for banks adopting the Standardized and Foundation Internal Ratings-Based (IRB) approaches will begin in January Those banks that wish to adopt the Advanced IRB approach will begin their parallel run in January 2007 and “go live” in 2008 SEC’s CSE Framework Released in June 2004, this framework establishes a voluntary alternative method for broker-dealers to compute regulatory capital charges and embodies many of the risk management principles of Basel II The CSE/Basel II timetable is more compressed for investment banks than for U.S. commercial banks. Applications have been submitted (some already approved) to the SEC for treatment under the CSE, with the SEC engaged in reviews throughout 2005 Final U.S. Guidance U.S. Regulators announced in April a delay in the release of the Notice of Proposed Rulemaking (NPR), expected to be released in June 2005 NPR will provide key guidance to banks for finalizing their Basel II implementation efforts No revised date for release has been officially announced but is expected 4Q05-1Q06 U.S. Qualification Process Institutions are required to file formal notice with their primary regulator of intent to use the “advanced approach” 18 months prior Advanced approach must apply across all “material business lines”. Exemption of non significant business lines and asset classes requires supervisory approval Supervisory review of the parallel run will provide the basis for the qualification decision. Parallel run requires: Full implementation of models, methodologies and systems Use of “reliable and well-established” data sets Quarterly reporting to regulators An institution’s Basel II implementation plan also will be a critical feature in the qualification process: Must include a self assessment of current status in meeting standards, gap analysis and remediation plan Needs to be board approved and filed with federal regulators by third quarter of 2005 Must demonstrate that adequate resources have been budgeted and made available

6 6 Confidential – All rights reserved – Ernst & Young LLP 2005 Implementation Timeline

7 7 Confidential – All rights reserved – Ernst & Young LLP 2005 Remaining Open Issues Implementation Timing in U.S. Basel II implementation timetable called into question with the announced delay in the release of the NPR U.S. regulators are expected to impose a 6- to 12-month “parallel processing” requirement for the advanced credit, market and operational regulatory capital methodologies that will drive consolidated U.S. reporting under Basel II Current indications are that the required parallel processing period will begin between January 1, 2007 and July 1, 2007 and end with live processing on January 1, 2008 Home/Host Responsibilities Basel II will not lead to a flawlessly consistent banking framework due to legal and market differences across jurisdictions. Firms may be subject to redundant and uncoordinated reviews by multiple regulatory jurisdictions The Basel Accord Implementation Group group has developed a dozen case studies for supervisors using live examples

8 8 Confidential – All rights reserved – Ernst & Young LLP 2005 Current State of Industry General Regulators initially indicated that there would be 10 mandatory Basel II banks in the U.S. - due to merger activity, this number has dropped to 7 mandatory banks. However, many opt-in banks are beginning to make firmer commitments to Basel II Mandatory and opt-in firms have developed baseline implementation plans and established a Basel II program management structure. These firms are now focused on meeting US qualification requirements Current state assessment Gap analysis Remediation plans U.S. regulators are beginning on-site visits, focusing on overall Basel II preparedness U.S. firms are responding to requests for information from host supervisors Firms are examining ways to link regulatory initiatives -- SOX, ORM, Compliance -- to drive cost efficiencies Credit Risk Implementation of dual ratings assignment and quantification methodologies for wholesale exposures Refinement of segmentation framework and parameter estimates quantification methodology for retail exposures Enhancement of internal controls related to model/process validation and Board and senior management oversight Build/augmentation of data warehouse capabilities to collect historical default and loss data for credit portfolios, and input data for rating assignment models Building risk weighted asset calculator Enhancement of systems for internal reporting and public disclosure Focus on the integration of risk and finance data Operational Risk Review of operational risk management framework and organizational structures Institutionalization of loss data collection processes, normalizing external data Refocus on self assessment process, key indicators and risk reporting Assessment of first iteration of operational risk quantification models Review of economic capital calculation and allocation process

9 9 Confidential – All rights reserved – Ernst & Young LLP 2005 Basel II: Other Challenges Level and Diverse Playing Field Consistency between Accounting Standards and Basel II  Bifurcated approach to Basel II in the US may result in added complexity and cost for foreign banks that elect to use the foundation approach in their home country  One year head start, in terms of reduced regulatory capital, for firms using the standardized and foundation approach (2007 start) compared to firms using the advanced approaches (2008 start)  The Fed is studying Basel II effects on competitiveness of processing banks, mortgages, small business lending, consolidation and credit card lending  Inconsistency in definitions between US GAAP and IAS accounting standards and Basel II. Conflicting definitions could lead to multiple sets of data and reporting requirements  Key areas of overlap are definitions of default and impairment, trading book and valuation of exposures, disclosures, and capital management Loss Given Default Stress Testing  Banks that adopt the advanced IRB approach will need to consider stress scenarios (economic downturns) in estimates of Loss Given Default

10 10 Confidential – All rights reserved – Ernst & Young LLP 2005 Disclosure Requirements  Lack of guidance regarding disclosure requirements  Amount of disclosure should be commensurate with the size, risk profile, and complexity of the firm's operations  Risk management framework should be disclosed in a manner which allows investors and counterparties to determine whether a firm effectively identifies, assesses, monitors, and controls/mitigates risk Data Integrity Issues  Variety of data requirements across business lines  Ability to manage data across legal entities (geographically) when most firms manage according to business line (functionally)  Quantification of rating systems  Operational risk data availability and relevance and scaling of external data  Establishing data collection standards and performing independent testing Materiality Thresholds  Need to determine when a subsidiary, business line or asset class is considered material  Expectation that firms will develop more risk sensitive techniques for allocating capital Basel II: Other Challenges (cont’d)

11 11 Confidential – All rights reserved – Ernst & Young LLP 2005 Contact Information Brian J. Boyle Manager Ernst & Young LLP (212)

12 Confidential – All rights reserved – Ernst & Young LLP © 2005 Ernst & Young LLP. All Rights Reserved. Ernst & Young is a registered trademark.


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