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Weekend Talks in Basel Spur on Risk and Data Agenda for 2010

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As predicted by A-Team Group last week, the weekend’s discussions in Basel between central bankers, regulators and a number of representatives from the private sector helped to kick off the risk management agenda for 2010. The group discussed the proposals enshrined in the Basel Committee on Banking Supervision’s (BCBS) published in December and indicated that time was of the essence in getting these finalised before the end of the year.

President Jean-Claude Trichet, who chairs the group and is president of the European Central Bank (ECB), emphasised that “timely completion of the Basel Committee reform programme is critical to achieving a more resilient banking system that can support sound economic growth over the long term”.

According to the central bank, the central bank governors and heads of supervision present at the meeting lauded the work of the BCBS with regards to its potential to strengthen the level and quality of international capital and liquidity standards. They also provided their own input into how progress can be made going forward in a number of key areas, including liquidity risk reporting, accounting standards and measurement of systemic risk.

The group stressed that it is essential that accounting standards setters and supervisors develop a truly robust provisioning approach based on expected losses, a significant change from current practices. It pointed to the BCBS’s August 2009 Guiding Principles for the replacement of IAS 39 as a building block for this change. The principles are aimed at ensuring that accounting reforms address broader concerns about procyclicality and systemic risk by the reworking of the fair value measurement approach. The group has asked the BCBS to come up with practical proposals related to expected losses provisioning by March, at which point it will be discussed during its scheduled meeting.

According to the group, a sound expected losses provisioning approach should address the deficiencies of the incurred loss approach without introducing an expansion of fair value accounting. Accounting for expected losses would allow banks to provide for losses over the duration of a loan, rather than, as now, waiting until the losses have occurred. This should thus promote adequate and more forward looking provisioning through early identification and recognition of credit losses in a consistent and robust manner and address concerns about procyclicality under the current incurred loss provisioning model, or so the logic goes.

Furthermore, such an approach should incorporate a broader range of credit information, both quantitative and qualitative, draw from banks’ risk management and capital adequacy systems and be transparent and subject to appropriate internal and external validation by auditors, supervisors and other constituents. So-called “through the cycle” approaches that are consistent with these principles and which promote the build up of provisions when credit exposures are taken on in good times that can be used in a downturn would be recognised, according to the group.

But what does this all mean from a technology and data standpoint? Essentially, the focus of the work is on improving the “relevance” and “usefulness” of accounting standards rather than expanding the coverage of fair value. This will be centred on increasing transparency and therefore the depth of the data provided with pricing and valuations. Regulators and end clients will require firms to provide a sufficient level of data around how they achieved their pricing and figures for accounting. The changes should also lend to the cause of the chief risk officer (CRO) in endeavouring to get a better handle on a firm’s financial position.

It will also be interesting to see how these proposals and the subsequent decisions made impact the work of the International Accounting Standards Board (IASB) and that of the US focused Financial Accounting Standards Board (FASB), both of whom are looking at harmonising the fair value accounting space.

As well as accounting standards, the group discussed the introduction of a new framework of countercyclical capital buffers. The group believes such a framework could contain two key elements that are complementary. First, it is intended to promote the build up of appropriate buffers at individual banks and the banking sector that can be used in periods of stress. This would be achieved through a combination of capital conservation measures, including actions to limit excessive dividend payments, share buybacks and compensation. Second, it would achieve the broader macro-prudential goal of protecting the banking sector from periods of excess credit growth through a countercyclical capital buffer linked to one or more credit variables.

Supervisors are also working to develop proposals to address the risk of systemically important banks (SIBs) and, to this end, the Basel Committee has established a Macroprudential Group. The committee should develop a menu of approaches using continuous measures of systemic importance to address the risk for the financial system and the broader economy. This includes evaluating the pros and cons of a capital and liquidity surcharge and other supervisory tools as additional possible policy options such as resolution mechanisms and structural adjustments. This will then form a key input to the Financial Stability Board’s (FSB) initiatives to address the ‘too big to fail’ problem.

This week has also seen the release of the FSB’s own reform agenda plans for 2010, which includes many of the same considerations as those discussed at the weekend.

The Basel Committee is also reviewing the role that contingent capital and convertible capital instruments could play in the regulatory capital framework. This includes possible entry criteria for such instruments in Tier 1 and/or Tier 2 to ensure loss absorbency and the role of contingent and convertible capital more generally both within the regulatory capital minimum and as buffers.

On the liquidity risk front and based on information collected through the quantitative impact assessment, the BCBS will flesh out the details of the global minimum liquidity standard, which includes both the 30 day liquidity coverage ratio and the longer term structural liquidity ratio. Central bank governors and heads of supervision will then review concrete proposals on both capital requirements and liquidity risk later this year.

President Trichet added: “The group of central bank governors and heads of supervision will provide strong oversight of the work of the Basel Committee during this phase, including both the completion and calibration of the reforms.”

The fully calibrated set of standards will be developed by the end of 2010 to be phased in as financial conditions improve and the economic recovery is assured with the aim of implementation by the end of 2012. This includes appropriate phase in measures and grandfathering arrangements for a sufficiently long period to ensure a smooth transition to the new standards, according to the group.

This transition period will no doubt include a bout of intense technology investment by firms attempting to bring their risk management systems and regulatory compliance systems into line with the new requirements.

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