1. 1 Basel II’s Impact in the Emerging European Markets 15 th International Banking Congress Saint Petersburg, June 7-10, 2006 Piroska M. Nagy EBRD EBRD

2. 2 Outline of presentation Basel II update Impact of Basel II The EBRD’s role

3. 3 Basel II timeline Basel II is designed for large internationally active banks, but it will spread more widely: –Compulsory in the EU; adopted by the European Parliament. Implementation from Jan 1, 2007 –Will be introduced in many advanced economies: Canada, Japan, Switzerland, Singapore, Hong Kong, Australia –Delay in the USA: 2009 instead of 2008, and only the most sophisticated method allowed. They will modify Basel I for the other banks –Peer pressure will accelerate its introduction in other EMs (Asia, Latin America). In transition economies: Croatia, Albania, other SEEs; Kazakhstan, Russia.

4. 4 Basel II will be introduced in stages in many countries Full introduction of simple and more sophisticated approaches: Australia, Korea, Singapore, New Zealand, EU First Standardized Approach only, but in a year the Internal-Ratings Based approach: Hong Kong, Japan, Thailand Only Standardized Approach for the time being and later move to advanced ones at a date not yet known: China, India

5. 5 Basel II in one picture … ■ More risk-sensitive approaches ■ Banks can choose their approach - supervisors to approve ■ More recognition of credit risk mitigation ■ New capital charge for operational risk Pillar 1: Minimum capital requirement Basel II Pillar 2: Supervisory review of capital Pillar 3: Market discipline ■ Risk assessment is a bank responsibility ■ Supervisors to review banks’ calculations and strategy ■ Bank should hold more capital than the minimum required ■ Supervisors can levy additional capital charge operational risk ■ Disclosure requirements used as instrument of “peer pressure” ■ Banks to disclose information on data and modelling ■ Banks using more advanced methods have to disclose more

6. 6 Impact of Basel II On : Regulatory capital Bank behaviour Industry competition and consolidation Macro economy Special issues in CEEs

7. 7 Impact of Basel II – Capital: the biggest question Global Individual/regional

8. 8 Hungary – QIS3 and QIS5 outcomes Credit risk Op risk TOTAL

9. 9 Summary Advanced economies: capital requirement of banks with good risk management and reasonable portfolios will decline Emerging Markets the results will be very diverse Winners Winners:  Banks that can afford expensive models and IT  Banks that improve their risk management and database  Start early with the preparations!  Banks with large retail exposures – the winning asset class of Basel IILosers:  Banks with weak portfolio and risk management quality  Banks whose lending is concentrated on low or non-rated corporates and sub-investment grade sovereigns  Banks that delay preparations

10. 10 Impact on bank behaviour Big improvement in risk management. In emerging markets, it is a “mini-revolution” Better risk management will help better pricing of credit risk by business line Use of risk mitigation instruments is expected to jump Possible portfolio shakeouts Results clearly depend on the type of approach chosen

11. 11 Impact on banking industry Further bank consolidation can be expected Dispersion is large (remember the Hungarian case) – clear winners and losers Large banks have an edge because only they can afford best IT and models. The result will be freed-up capital for expansion Medium-sized and small banks without a clear niche may be targeted In Central and Eastern Europe and also in Russia, ongoing bank consolidation may get a boost from Basel II

12. 12 Impact on macro economy Probably positive on growth: better pricing  better capital allocation  higher potential growth Procyclicality: big debate, but probably increases procyclicality Some concerns over systemic risks (home-host; boost to already high household debt)

13. 13 Special issues in emerging Europe In many countries where main banks are foreign-owned, the Basel II process is parent bank-controlled Non-foreign owned, local banks face huge challenges in complying with Basel II Supervisory preparedness is an additional challenge

14. 14 The Home-Host Supervisory Issue Basel II’s approach: supervision is based on consolidated banking group Thus, home supervisor takes the lead in supervision and monitoring, and in coordinating with host supervisor Problem: if a country’s banking system is dominated by foreign-owned banks/their subsidiaries, host supervisors lose power while still are responsible by law for financial sector stability There should information-sharing but also perhaps cost-burden sharing

15. 15 Special Issue: Basel II provides for more mitigation & higher level of protection Range of CRM instruments Level of protection Basel II Basel I

16. 16 What are these CRMs? Well- known in advanced economies but not yet in Emerging Europe Credit Risk Mitigation instruments »Guarantees »Credit derivatives »Securitization »Netting operations »Collateralization For many of these, banks will need high- quality credit enhancers such as the EBRD For many of these, some legal and regulatory adjustments may be needed

17. 17 Why is the EBRD interested in all this? EBRD has a mandate to promote financial sector development and Basel II is the new industry standard Basel II essentially leverages the regulatory system to improve risk management in banks and EBRD supports this Basel II gives incentives for developing capital market products – exactly what is missing to complete “transition” in the financial sector

18. 18 What can the EBRD do? Help develop better risk management practices As part of this, work with banks to introduce properly designed risk mitigation instruments (primarily securitization, some simple credit derivatives) Provide credit enhancement Help address potential need for higher regulatory capital Work with regulators to modify the legal and tax framework.

19. 19 Лондон Пирошка Нагь Старший банкир и советник эл. почта: nagyp@ebrd.comnagyp@ebrd.com тел.: (44 207) 338 7861 Москва Ник Тессейман Начальник отдела финансовых организаций, Москва эл. почта: tesseymn@mos.ebrd.com tesseymn@mos.ebrd.com тел.: (7 495) 787 1111 Контакные лица