Chapter two - International Risk Regulation. Flashcards
What is the BIS and the role?
Bank for international settlements, serves as a bank for central banks and international organisations. It provides a focus point for regulations
what is important to know about the BIS
it does not provide FS or accept deposits from private individuals or corporate entities.
Its regulations are guidelines, they do not have any force in law!
1.2 - why does the Basel Committee on Banking Supervision (BCBS) exist?
enhances understanding of supervisory issues and improves the quality of banking supervision. They ensure banks have enough sufficient reserves to withstand risks.
what are the capital adequacy requirements three pillars?
Pillar 1 =- semi-formulaic approach to the calculation of the minimum level of capital which a firm should have.
Pillar 2 = Enables a firm to set its own level of capital and liquidity to hold. A process called ICAAP needs to be done, internal capital adequacy assessment process. For investment managers, this is called ICARA (internal capital adequacy and risk assessment)
Pillar 3 = public disclosure to certain prescribed aspects of the firm’s capital and approach to risk management.
what are the drivers for the capital adequacy of banks?
two things - risk and event
systematic risk!
1929 Wall street crash in the US - Meant in the US, deposit insurance and central bank ‘Lender-of-last resort’ provisions were introduced to reduce further risk. However, this caused moral hazards.
What are the two types of capital?
Economic - Bank’s best estimate of the capital it needs to manage its own risk profile.
Regulatory - The mandatory level of capital which a regulator requires a bank to hold.
who is the primary global standard-setter for prudential regulations?
The Basel committee on Banking Supervisions (BCBS)
Who stipulates the minimum capital ratios which should be maintained by banks in member countries and what three things have they included?
what are the minimum set of risks for which capital ratios are to be maintained?
Basel Accord (capital buffers, leverage ratio, liquidity requirements)
credit, market, and operational risk
the higher these risks = the higher capital held.
1.3 how does the committee seek to achieve the setting of minimum standards established by the Basel Committee for the regulation and supervision of banks
Which country does not follow the basel accord set by the BCBS?
- sharing supervisory issues
- approaches and techniques to promote common understanding and improve cross-border cooperation
- exchange information on developments in banking sector to help identify current or emerging risks for system
ALL COUNTRIES APART FROM CHINA FOLLOW THE BASEL ACCORD SET BY THE BCBS
Why has core principles for effective banking supervision been set?
to define minimum benchmark foir assessing the quality of global supervisory systems. They enable country who want to sign up to the Basel Accord to identify any work necessary.
1.3 What are the series of preconditions?
1 - sound macroeconomic policies
2 - well-established framework for financial stability
3 - well-developed infrastructure
4 - clear framework
5- mechanisms for systemic protection
6 - effective market discipline
how many core principles for effective banking supervisions are there and how are they categorised?
29
1-13 = supervisory powers, responsbilties and functions
14-29 = supervisory expectations of banks, emphasises the importance of good corporate governance and risk management, as well as compliance with supervisory standards.
2.1 What is the purpose of the Basel Accord?
Aims to encourage improved risk management through the use of three mutually reinforced pillars
What is pillar 1 and calculation?
Minimum regulatory capital requirement
Pillar 1 = formulaic approach to the calculation of regulatory capital
capital / Credit + Market + Operational ) 8%
what is pillar 2?
Supervisory review process
Involves firms submitting information to regulator to work out how much capital they should hold.
This information includes:
- controls infrastructure quality
- risks not covered in pillar 1
- way risk profile relates to strategic and financial plans
- way risk is managed
what is pillar 3?
Market discipline
firms required to publish information about the way they manage risks.
what are the two new liquidity requirements in the Basel accord?
Two new liquidity requirements: Net stable funding ration (NSFR) and the liquidity coverage ration (LCR)
What is a sound practice principle?
This is produced from time-to-time and provides guidance for firms. These cover areas involve:
- operational risk, credit risk, interest rate, liquidity risk
What are UK Investment management firms subjected to the new investment firms prudential regime (Known as IFPR or the New Regime) required to perform?
Perform an internal capital and liquidity assessment, which meets the Pillar 2 requirements.
This requires firms to submit risk, capital and liquidity information
what are the key elements of the internal capital and liquidity assessment framework?
4 things and description
- The firms Risk exposure - provides clear risk appetite by risk category and the quantification of any risks not included in pillar 1. Includes - credit,market,operational,liquidity, insurance, concentration, business (strategic) risk, residual, securilsation, Interest rate risk, pension obligation risk.
- The firms view on the adequacy of its risk management processes (this enables a firm to hold less capital than the gross risk to which it is exposed too)
- The firms financial and capital plans (summary of current and projected financial and capital positions including strategic position, balance sheet strength and future profits.
- Stress and scenario tests applied by the firm to its risk and financial plans. (Stress testing - varying one input factor at a time) (Scenario analysis - constructing realistic scenarios)
what does the firms capital and liquidity adequacy include?
It needs to be compared to the aggregated results of the various seperate risk assessments.
An overall view then needs to be given by the firm of its capital and liquidity adequacy.
At technical level this requires a quantitative technique for combining risks, and any correlated used to derive diversification benefits need to be justified.
What is the “Use test” and the evidence included
The extent to which risk-based decision making is embedded within the firm.
Evidence would include:
- senior management or board challenge, review and sign-off procedures (including writing meeting notes from boards)
- The extent to which the internal capital and liquidity assessment is part of the firms capital and liquidity management process (includes capital modelling, scenario analysis, stress testing - an example would be prices/charges and the level and nature of future business)
What is the last stage in the supervisory review process? what is it based on? what does the internal capital and liquidity assessment process designed to incentives?
For the regulators to set the amount of capital and liquidity which the firm must hold. It is based on the firm’s internal capital and liquidity assessment and the associated discussions with the regulator.
incentivizes firms to increase the quality of their risk management, holding less pillar 1 capital and seeing pillar 2 evidence of internal incentives for staff.
what are the benefits for an internal capital and liquidity assessment process? what are the stages needed for senior management time?
Business strategy - seniors can become more diligent in their inclusion of risk factors earlier
Risk Assessments - take more seriously as regulators ask them.
Main benefit of internal capital and liquidity assessment process - an increased focus on risk within firm and senior management risk responsibility
Requires senior management time at the design phase, risk and financial data collection phase, and for the sign-off phase
