Friday, April 18, 2008

Basel Committee unveils plans to strengthen global financial markets.

On the close heels of the report presented last week by the Financial Stability Forum (FSF) , comes an additional report from the Basel Committee on Banking Supervision(BCBS).
In its report to the G-7 ministers, the FSF provided a brief outline of the steps that are planned to improve market resiliency. The BCBS in its report presented on April 16th, provides additional details with a general timeline for the implementation of these measures.

The measures are addressed towards five main areas: Capital, Risk Management, Liquidity Management, Disclosures and Valuation.

1. Capital: Economists, central bank governors and others have attributed the weakening of financial markets to inadequate capital maintenance by banks and other financial institutions that did not commensurate with the level of risk that these banks took on over the years. Towards this end, the BCBS will introduce measures to ensure adequate capital, to better capture off balance sheet exposures and to 'improve regulatory capital incentives'.
Specifically, the committee will revise the BASEL framework to establish higher capital requirements for certain complex structured credit products. Besides this, the capital requirements associated with the liquidity extended to support off balance sheet vehicles will also be strengthened.Details of this proposal are expected to be provided later this year. The Committee, in cooperation with the International Organization of Securities Commissions (IOSCO), is extending the scope of its existing proposed guidelines for "incremental default risk" to include other potential event risks in the trading book.This is planned for 2010. Until this is put in place, an interim treatment will be used for complex securitisations that are held in the trading book. The Committee expects to issue its proposal for public consultation later this year, and it also will conduct a quantitative impact assessment.
The committee also plans to monitor Basel II minimum capital requirements and capital buffers over the credit cycle. If these are found to be inadequate, then such requirements laid out in Basel II will be enhanced in order to provide a sound capital framework commensurate with the banks' risk profiles.

2. Risk Management: The committee plans to revise Pillar 2 associated with the Supervisory review process by providing additional tools and guidance.

3. Liquidity Management:The committee plans to publish global sound practice standards for the management and supervision of liquidity risks. This is planned to be published in July and will be open for consultation.

4. Disclosures: Pillar 3 (market discipline) of the framework ensures adequate disclosures in the area of complex securitization. There will be additional guidance in the area of market discipline by 2009.

5. Valuation: The bank plans to develop guidance that supervisors can use to determine the strength of the banks valuation processes. The committee believes that weak valuation practices contributed to the recent market turbulence. This measure will hopefully reduce a recurrence of such an event.

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