Chapter 19: Risk frameworks Flashcards
3 Broad types of risk framework
- mandatory
- advisory
- proprietary
Mandatory risk frameworks
must be followed in order for an organisation to carry out some types of business.
They must be complied with by firms working in particular industries.
Advisory risk frameworks
Offer guidelines for firms wishing to set up their own risk management framework.
These are usually generic.
Proprietary risk frameworks
These are frameworks used by firms for some specific purposed (most commonly credit rating)
2 Most important mandatory risk frameworks
Basel II and Solvency II
Basel II
The global risk framework designed to promote stability in the banking sector.
By whom was Basel II published and updated
The Basel Committee on Banking Supervision (BCBS)
which was established in 1974 by the governers of the central banks of the Group of Ten (G10) countries under the auspices of the Bank for International Settlements (BIS).
3 Pillars of Basel II
- minimum capital requirements
- supervisory review process; and
- market discipline
When was Basel II introduced
2004
Basel II:
4 aspects to supervisory review
- firms have an internal process for monitoring capital adequacy
- this forms the basis for review by the regulator, who needs to make sure the process is sound
- the regulator also needs to ensure that the firm is operating above minimum level, and has an obligation to intervene quickly if there is a risk of capital falling below minimum levels.
- the regulator should also verify that the approach used to quantify operational risk is consistent with the business, and whether market risk is correctly measured.
Basel II:
Market discipline
This involves promoting transparency by requiring firms to publish details of their risks, their capital and the ways in which thy manage risk.
The aim is to make sure that sufficient information about a firm is disclosed for the market to assess the risks faced by the firm, and for the cost of capital to be adjusted accordingly.
Why and when was Basel III introduced
In response to the global financial crisis, Basel III stregthens certain aspects of the first pillar of Basel II.
It was introduced by the Basel Committee for Banking Supervision in 2010.
Solvency II
The risk framework for insurers operating in the EU, that was due to be implemented on 1 November 2012.
3 Pillars of Solvency II
- quantitative requirements
- qualitative requirements
- disclosure
Solvency II
2 Quantitative requirements
- Minimum capital requirement (MCR)
- Solvency Capital requirement
The SCR is the main standard by which solvency is measured, below which regulatory action is taken.
The MCR is a lower capital requirement, but any firm falling below the MCR would lose its authorisation.
SCR must be achievable with a 99.5% level of confidence over a one-year time horizon.
